Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,830,000 and will last for 6 years. Variable costs are 36 percent of sales, and fixed costs are $156,000 per year. Machine B costs $4,490,000 and will last for 8 years. Variable costs for this machine are 28 percent of sales and fixed costs are $112,000 per year. The sales for each machine will be $8.98 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.)
	Option 1: $ -3,729,671.5 Option 2: $ -4,122,268.5 Option 3: $ -10,958,495.77 Option 4: $ 3,320,848.49 Option 5: $ -2,516,151.51

(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.)
	Option 1: $-6,680,937.98 Option 2: $-7,384,194.61 Option 3: $-2,352,346.14 Option 4: $3,484,653.86 Option 5: $-12,549,593.04

Answer 1

Solution :-

In Case of Machine A

Depreciation every year = $1,830,000 / 6 = $305,000

Net Cash Flow Every Year =

Net Operating Cash flow
Sales	$8,980,000.00
Less :- Variable Cost (36% of Sale )	$3,232,800.00
Less :- Fixed Cost	$156,000.00
Less :- Dep	$305,000.00
EBIT	$5,286,200.00
Less :- Tax @ 35%	$1,850,170.00
Earning after tax	$3,436,030.00
Add :- Dep ( Non Cash Item )	$305,000.00
Operating Cash Flow	$3,741,030.00

Now

Equivalent Annual Cost = [ - Initial Cost + Cash flow every Year * PVAF ( 10% , 6 ) ] * A/P ( 10% , 6 )

= [ - $1,830,000 + ( $3,741,030 * 4.3553 ) ] * 0.2296

= [ - $1,830,000 + ( $16,293,160.93 ) ] * 0.2296

= $3,320,848.49

Therefore Correct Answer is Option :- 4

Now in case of Machine B

Depreciation every year = $4,490,000 / 8 = $561,250

Net Operating Cash flow
Sales	$8,980,000.00
Less :- Variable Cost ( 28% of Sales )	$2,514,400.00
Less :- Fixed Cost	$112,000.00
Less :- Dep	$561,250.00
EBIT	$5,792,350.00
Less :- Tax @ 35%	$2,027,322.50
Earning after tax	$3,765,027.50
Add :- Dep ( Non Cash Item )	$561,250.00
Operating Cash Flow	$4,326,277.50

Equivalent Annual Cost = [ - Initial Cost + Cash flow every Year * PVAF ( 10% , 8 ) ] * A/P ( 10% , 8 )

= [ - $4,490,000 + ( $4,326,277.50 * 5.335 ) ] * 0.1874

= [ - $4,490,000 + $23,080,371.17 ] * 0.1874

= $3,484,653.86

Therefore Correct Answer is Option :- 4

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