Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,010,000 and will last for 4 years. Variable costs are 40 percent of sales, and fixed costs are $130,000 per year. Machine B costs $4,790,000 and will last for 7 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 $9.58 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.) $ -4,629,896.25 $ -3,033,521.32 $3,193,478.68 $ -4,188,953.75 $ -9,615,854.4 (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.) $ -13,899,876.17 $ -2,561,402.34 $3,665,597.66 $- -12,576,078.44 $ -12,469,979.37

Answer 1

Since we need EAC that is equivalent annual cost, so sales figures are irrelevant, we will calculate OCF using bottom up approach
					Machine A	Machine B
Variable costs (9580000 x 40%/28%)	$      (3,832,000)	$      (2,682,400)
Fixed costs	(130,000.00)	(113,000.00)
*Depreciation	(502,500.00)	(684,285.71)
EBT	$      (4,464,500)	$      (3,479,686)
Tax at 35% of EBT	(1,562,575)	(1,217,890)
Net income	(2,901,925)	(2,261,796)
+ Depreciation	502,500.00	684,285.71
Annual OCF	(2,399,425.00)	(1,577,510.00)
*Depreciation	2010000/4	4790000/7
EAC of A = -2010000(A/P,10%,4) - 2399425
EAC of A = -2010000(0.315470804) - 2399425
EAC of A = -634096.32 - 2399425
EAC of A = -3033521.32	Option B
EAC of B = -4790000(A/P,10%,7) - 1577510
EAC of B = -4790000(0.2054055) - 1577510
EAC of B = -983892.34 - 1577510
EAC of B = -2561402.34	Option B