Question

ABC Inc., a wedge manufacturer, is deciding between two machines used for making wedges. Machine A will cost $70,000 and Machine B will cost $120,000. The annual before-tax operating costs for Machine A and B are $7,500 and $6,000, respectively. Machine A will last for 2 years before it has to be replaced, whereas Machine B will last for 3 years before it must be replaced. The machines are subject to CCA rate of 30%, and the company's marginal tax rate is 35%. If the required return for ABC is 16%, which machine should ABC choose? Assume that salvage is zero.

Multiple Choice

• Choose Machine B as its EAC is lower by $6,761.

• Choose Machine B as its EAC is higher by $6,761.

• Choose Machine B as its EAC is higher by $1,480.

• Choose Machine A as its EAC is lower by $1,480.

• Choose Machine A as its EAC is lower by $6,761.

Answer 1

PARTICULARS	MACHINE A
INVESTMENT	70000
DEPRCEIATION CCA FOR PLNAT & EQUIPMENT
IS 30%
Ist YEAR CLAIM ONLY 15% ( HALF OF 30)	70000	10500
2 nd YEAR 30%	59500	17850
WDV	41650
PV FACTORE	YEAR 1	YEAR 2
16%	0.862	0.743162901	1.605
	YEAR1	YEAR2
INVESTMENT	70000		70000
BEFORE TAX OPERATING COST	7500	7500
DEPRECIATION	10500	17850
TOTAL COST	18000	25350
TAX ADVANTAGE 35%	6300	8872.5
NET COST	11700	16477.5
LESS DEPRECIATION NON CASH ITEM	10500	17850
CASH OUTFLOW	1200	-1372.5
LESS TAX ADVANTAGE OF CAPTAL LOSS-WDV -41650*35%		14577.5
NET CASH OUTFLOW	1200	-15950
PV FACTOR	0.862	0.743
PRESENT VALUE CASH OUTFLOW	1034.4	-11850.85	-10816.45
TOTAL COST			59183.55
EQUIVALENT CASH FLOW	TOTAL OUTFLOW/TOTALPV FACTOR		59183.55/1.605
			36869.16
PARTICULARS
INVESTMENT	MACHINE B
	120000
DEPRCEIATION CCA FOR PLNAT & EQUIPMENT
IS 30%
Ist YEAR CLAIM ONLY 15% ( HALF OF 30)	120000	18000
2 nd YEAR 30%	102000	30600
3 rd YEAR   30%	71400	21420
	49980
PV FACTORE	YEAR 1	YEAR 2	YEAR 3
16%	0.862	0.743162901	0.641	2.246
	YEAR 1	YEAR 2	YEAR 3	TOTAL
INVESTMENT	120000			120000
BEFORE TAX OPERATING COST	6000	6000	6000
DEPRECIATION	18000	30600	21420
TOTAL COST	24000	36600	27420
TAX ADVANTAGE 35%	8400	12810	9597
NET COST	15600	23790	17823
LESS DEPRECIATION-NON CASH ITEM	18000	30600	21420
CASH OUTFLOW	-2400	-6810	-3597
LESS TAX ADVANTAGE OF CAPTAL LOSS-WDV -49980*35%			17493
NET CASH OUTFLOW	-2400	-6810	-21090
PV FACTOR	0.862	0.743	0.641
PRESENT VALUE CASH OUTFLOW	-2068.8	-5059.83	-13518.69	-20647.32
TOTAL COST				99352.68
EQUIVALENT CASH FLOW-3 YEARS				99352.68/2.246
	TOTAL OUTFLOW/TOTALPV FACTOR			44235.39
DIFFERENCE				7366.23
ANSWER NONE OF THE OPTIONS
Choose Machine A as its EAC is lower by $7366