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In: Accounting

Vandelay Industries is considering the purchase of a new machine for the production of latex. Machine...

Vandelay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1.98 million and will last for six years. Variable costs are 35 percent of sales and fixed costs are $187,000 per year. Machine B costs $5,400,000 and will last for nine years. Variable costs for this machine are 30 percent of sales and fixed costs are $145,000 per year. The sales for each machine will be $12.4 million per year. The required return is 10 percent and the tax rate is 21 percent. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Calculate the EAC for each machine.

Solutions

Expert Solution

Machine A:

Cost of Machine = $1,980,000
Useful Life = 6 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $1,980,000 / 6
Annual Depreciation = $330,000

Annual Net cash flows = [Sales - Variable Costs - Fixed Costs - Depreciation] * (1 - tax) + Depreciation
Annual Net cash flows = [$12,400,000 - 35% * $12,400,000 - $187,000 - $330,000] * (1 - 0.21) + $330,000
Annual Net cash flows = $6,288,970

NPV = -$1,980,000+ $6,288,970* PVIFA(10%, 6yrs)
NPV = -$1,980,000 + ($6,288,970 * 4.354)
NPV = $25,402,175

EAC = NPV / PVIFA(10%, 6)
EAC = $25,402,175 / 4.354
EAC = $5,834,215

Machine B:

Cost of Machine = $5,400,000
Useful Life = 9 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $5,400,000 / 9
Annual Depreciation = $600,000

Annual Net cash flows = [Sales - Variable Costs - Fixed Costs - Depreciation] * (1 - tax) + Depreciation
Annual Net cash flows = [$12,400,000 - 30% * $12,400,000 - $145,000 - 600,000] * (1 - 0.21) + $600,000
Annual Net cash flows = $6,868,650

NPV = -$5,400,000 + $6,868,650 * PVIFA(10%, 9yrs)
NPV = -$5,400,000 + $6,868,650 * 5.758
NPV = $34,149,687

EAC = NPV / PVIFA(10%, 9)
EAC = $34,149,687/ 5.758
EAC = $5,930,824


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