Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,230,000 and will last for 6 years. Variable costs are 34 percent of sales, and fixed costs are $146,000 per year. Machine B costs $4,750,000 and will last for 9 years. Variable costs for this machine are 30 percent of sales and fixed costs are $87,000 per year. The sales for each machine will be $9.5 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

	Machine A	Machine B
Initial Cost	2230000	4750000
Sales	9500000	9500000
VC	3230000	2850000
FC	146000	87000
Depreciation	371666.6667	527777.7778
Tax Savings due to Depreciation	130083.3333	184722.2222
Net Cashoutflow	3245916.667	2752277.778
Yr	Machine A	PVF @10%	PV of CF	Machine B	PVF @10%	PV of CF
1	3245916.667	0.909090909	2950833.333	2752277.778	0.909090909	2502070.707
2	3245916.667	0.826446281	2682575.758	2752277.778	0.826446281	2274609.734
3	3245916.667	0.751314801	2438705.234	2752277.778	0.751314801	2067827.031
4	3245916.667	0.683013455	2217004.758	2752277.778	0.683013455	1879842.755
5	3245916.667	0.620921323	2015458.871	2752277.778	0.620921323	1708947.959
6	3245916.667	0.56447393	1832235.337	2752277.778	0.56447393	1553589.054
7				2752277.778	0.513158118	1412353.685
8				2752277.778	0.46650738	1283957.896
9				2752277.778	0.424097618	1167234.451
	NPV		14136813.29			15850433.27
	Annuity factor	4.355260699			5.759023816
	EAC		3245916.667			2752277.778