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P10-24 Comparing Mutually Exclusive Projects [LO4] Vandalay Industries is considering the purchase of a new machine...

P10-24 Comparing Mutually Exclusive Projects [LO4] Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,370,000 and will last for 6 years. Variable costs are 36 percent of sales, and fixed costs are $142,000 per year. Machine B costs $4,640,000 and will last for 10 years. Variable costs for this machine are 28 percent of sales and fixed costs are $113,000 per year. The sales for each machine will be $9.28 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.)

Solutions

Expert Solution

(a)The NPV of Machine A is as follows:

Machine A
Year 0 1 2 3 4 5 6
Initial Cost -2370000
Sales 9280000 9280000 9280000 9280000 9280000 9280000
Variable cost -3340800 -3340800 -3340800 -3340800 -3340800 -3340800
Fixed Cost -142000 -142000 -142000 -142000 -142000 -142000
Depreciation -395000 -395000 -395000 -395000 -395000 -395000
EBT 5402200 5402200 5402200 5402200 5402200 5402200
Taxes at 35% -1890770 -1890770 -1890770 -1890770 -1890770 -1890770
Net Income 3511430 3511430 3511430 3511430 3511430 3511430
Add back Dep. 395000 395000 395000 395000 395000 395000
Net Cash flow -2370000 3906430 3906430 3906430 3906430 3906430 3906430
NPV $ 14,643,521.05

EAC of Machine A = r*NPV/(1-(1+r)^-n) =0.10(14,643,521.05)/(1-1.10^-6) = $3,362,260.51

(b) (a)The NPV of Machine B is as follows:

Machine A
Year 0 1 2 3 4 5 6 7 8 9 10
Initial Cost -4640000
Sales 9280000 9280000 9280000 9280000 9280000 9280000 9280000 9280000 9280000 9280000
Variable cost -2598400 -2598400 -2598400 -2598400 -2598400 -2598400 -2598400 -2598400 -2598400 -2598400
Fixed Cost -113000 -113000 -113000 -113000 -113000 -113000 -113000 -113000 -113000 -113000
Depreciation -464000 -464000 -464000 -464000 -464000 -464000 -464000 -464000 -464000 -464000
EBT 6104600 6104600 6104600 6104600 6104600 6104600 6104600 6104600 6104600 6104600
Taxes at 35% -2136610 -2136610 -2136610 -2136610 -2136610 -2136610 -2136610 -2136610 -2136610 -2136610
Net Income 3967990 3967990 3967990 3967990 3967990 3967990 3967990 3967990 3967990 3967990
Add back Dep. 464000 464000 464000 464000 464000 464000 464000 464000 464000 464000
Net Cash flow -4640000 4431990 4431990 4431990 4431990 4431990 4431990 4431990 4431990 4431990 4431990
NPV $ 22,592,659.97

EAC of Machine B = r*NPV/(1-(1+r)^-n) = 0.10*22592659.97/(1-1.10^-10) = $3,676,851.37

jeff jeffy answered 2 years ago
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