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PPG Industries is considering the purchase of a new machine to produce outdoor paint. Machine A...

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

Solutions

Expert Solution

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


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