Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,360,000 and will last for 6 years. Variable costs are 39 percent of sales, and fixed costs are $122,000 per year. Machine B costs $4,310,000 and will last for 9 years. Variable costs for this machine are 29 percent of sales and fixed costs are $111,000 per year. The sales for each machine will be $8.62 million per year. The required return is 10 percent and the tax rate is 35 percent. Both machines will be depreciated on a straight-line basis. Required: (a) If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine A? (Do not round your intermediate calculations.) (b) If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine B? (Do not round your intermediate calculations.)

Answer 1

	A	B
Cost	2,360,000.00	4,310,000.00
Term	6	9
VC	39%	29%
FC	122,000.00	111,000.00

Annual Operating Cost per year
	Machine A	Machine B
Sales	8,620,000.00	8,620,000.00
VC	3,361,800.00	2,499,800.00
Contribution	5,258,200.00	6,120,200.00
FC	122,000.00	111,000.00
	5,136,200.00	6,009,200.00
Depreciation	393,333.33	478,888.89
	4,742,866.67	5,530,311.11
Tax @35%	1,660,003.33	1,935,608.89
PAT	3,082,863.33	3,594,702.22
+ Depreciation	393,333.33	478,888.89
Operating Cost	3,476,196.67	4,073,591.11

Calculation of PVIF
Year	1	2	3	4	5	6	7	8	9
PVIF	0.9091	0.8264	0.7513	0.6830	0.6209	0.5645	0.5132	0.4665	0.4241

PVAF
1-6 Years	4.3553
1-9-Years	5.7590

Calculation of EAC
Machine A
a	Initial Outlay	2,360,000.00
b	PV of Annual Operating Cost (1-6 Years)	15,139,742.73
c	a+b	17,499,742.73
d	PVAF (10%,6)	4.3553
e	EAV (c/d)	4,018,070.08
Machine A
a	Initial Outlay	4,310,000.00
b	PV of Annual Operating Cost (1-9 Years)	23,459,908.23
c	a+b	27,769,908.23
d	PVAF (10%,9)	5.7590
e	EAV (c/d)	4,821,981.83