In: Finance
PPG Industries is considering the purchase of a new machine to produce outdoor paint. Machine A costs $3,150,000 and will last for six years. Variable costs are 37 percent of sales, and fixed costs are $290,000 per year. Machine B costs $5,377,000 and will last for nine years. Variable costs for this machine are 32 percent of sales and fixed costs are $210,000 per year. The sales for each machine will be $11.8 million per year. The required return is 10 percent, and the tax rate is 23 percent. Both machines will be depreciated on a straight-line basis to 0 over the duration of the project (machine A over 6 years; machine B – 9 years.). Both machines will be worthless at the end of the project. The company plans to replace the machine when it wears out. Based on costs, which machine should the company choose and why? Please use excel if possible
Machine A
Time line | 0 | 1 | 2 | 3 | 4 | 5 | 6 | |||
Cost of new machine | -3150000 | |||||||||
=Initial Investment outlay | -3150000 | |||||||||
100.00% | ||||||||||
Sales | 11800000 | 11800000 | 11800000 | 11800000 | 11800000 | 11800000 | ||||
Profits | Sales-variable cost | 7434000 | 7434000 | 7434000 | 7434000 | 7434000 | 7434000 | |||
Fixed cost | -290000 | -290000 | -290000 | -290000 | -290000 | -290000 | ||||
-Depreciation | Cost of equipment/no. of years | -525000 | -525000 | -525000 | -525000 | -525000 | -525000 | 0 | =Salvage Value | |
=Pretax cash flows | 6619000 | 6619000 | 6619000 | 6619000 | 6619000 | 6619000 | ||||
-taxes | =(Pretax cash flows)*(1-tax) | 5096630 | 5096630 | 5096630 | 5096630 | 5096630 | 5096630 | |||
+Depreciation | 525000 | 525000 | 525000 | 525000 | 525000 | 525000 | ||||
=after tax operating cash flow | 5621630 | 5621630 | 5621630 | 5621630 | 5621630 | 5621630 | ||||
+Tax shield on salvage book value | =Salvage value * tax rate | 0 | ||||||||
=Terminal year after tax cash flows | 0 | |||||||||
Total Cash flow for the period | -3150000 | 5621630 | 5621630 | 5621630 | 5621630 | 5621630 | 5621630 | |||
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.1 | 1.21 | 1.331 | 1.4641 | 1.61051 | 1.771561 | ||
Discounted CF= | Cashflow/discount factor | -3150000 | 5110572.7 | 4645975.2 | 4223613.8 | 3839648.9 | 3490589.9 | 3173263.6 | ||
NPV= | Sum of discounted CF= | 21333664.2 |
Year or period | 0 | 1 | 2 | 3 | 4 | 5 | 6 | |
EAC | 4898366.8 | 4898366.8 | 4898366.8 | 4898366.8 | 4898366.8 | 4898366.8 | ||
Discount factor= | (1+discount rate)^corresponding period | 1.1 | 1.21 | 1.331 | 1.4641 | 1.61051 | 1.771561 | |
Discounted CF= | Cashflow/discount factor | 4453060.7 | 4048237 | 3680215.4 | 3345650.4 | 3041500.4 | 2765000.3 | |
NPV= | 21333664.21 | |||||||
EAC is equivalent yearly CF with same NPV = | 4898366.753 |
machine B
Choose machine B as it has higher EAC