Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,190,000 and will last for 6 years. Variable costs are 39 percent of sales, and fixed costs are $158,000 per year. Machine B costs $4,460,000 and will last for 10 years. Variable costs for this machine are 31 percent of sales and fixed costs are $97,000 per year. The sales for each machine will be $8.92 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.

(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?

Answer 1

		MACHINE A
	A	Annual Sales	$8,920,000
	B=0.39*A	Variable cost(0.39 * Sales)	$3,478,800
	C	Fixed Cost	$158,000
	D=A-B-C	Earning before depreciation(Before tax)	$5,283,200
	E=D*(1-0.35)	After tax Earning	$3,434,080
	F=2190000/6	Annual Depreciation	$365,000
	G=F*0.35	Depreciation tax shield	$127,750
	H=E+G	Annual Cash inflow	$3,561,830
	N	Number of years	6
	PV	Present Value of cash in Flows	$15,512,698.22	(Using PV function with Rate=10%, Nper=6, Pmt=-3561830)
	I	Investment in Machine A	$2,190,000.00
	NPV=PV-I	Net Present Value	$13,322,698.22
	PMT	Equivalent Annual Cash flow(EAC)	$3,058,990	(Using PMT function with Rate=10%, Nper=6, Pv=-13322698.22)
		MACHINE B
	A	Annual Sales	$8,920,000
	B=0.31*A	Variable cost(0.31 * Sales)	$2,765,200
	C	Fixed Cost	$97,000
	D=A-B-C	Earning before depreciation(Before tax)	$6,057,800
	E=D*(1-0.35)	After tax Earning	$3,937,570
	F=4460000/10	Annual Depreciation	$446,000
	G=F*0.35	Depreciation tax shield	$156,100
	H=E+G	Annual Cash inflow	$4,093,670
	N	Number of years	10
	PV	Present Value of cash in Flows	$25,153,830	(Using PV function with Rate=10%, Nper=10, Pmt=-4093670)
	I	Investment in Machine B	$4,460,000.00
	NPV=PV-I	Net Present Value	$20,693,830
	PMT	Equivalent Annual Cash flow(EAC)	$3,367,826	(Using PMT function with Rate=10%, Nper=10, Pv=-20693830)
	(a)	EAC for machine A	$3,058,990
	(b)	EAC for machine B	$3,367,826