Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,090,000 and will last for 4 years. Variable costs are 39 percent of sales, and fixed costs are $136,000 per year. Machine B costs $4,660,000 and will last for 7 years. Variable costs for this machine are 28 percent of sales and fixed costs are $89,000 per year. The sales for each machine will be $9.32 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.)
	(Click to select)$-4,576,052.25$-4,140,237.75$-9,279,714.46$3,130,521.02$-2,927,478.98

  

(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.)
	(Click to select)$3,579,720.37$-2,478,279.63$-12,065,303.18$-13,446,125.17$-12,165,541.82

Answer 1

Machine A:

Cost of Machine = $2,090,000
Useful Life = 4 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $2,090,000 / 4
Annual Depreciation = $522,500

Variable Costs = 39% * Sales
Variable Costs = 39% * $9,320,000
Variable Costs = $3,634,800

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $3,634,800 + $136,000
Pretax Operating Costs = $3,770,800

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$3,770,800 * (1 - 0.35) + 0.35 * $522,500
Annual OCF = -$2,268,145

NPV = -$2,090,000 - $2,268,145 * PVIFA(10%, 4)
NPV = -$2,090,000 - $2,268,145 * 3.169865
NPV = -$9,279,713.450425

EAC = NPV / PVIFA(10%, 4)
EAC = -$9,279,713.450425 / 3.169865
EAC = -$2,927,478.98

Machine B:

Cost of Machine = $4,660,000
Useful Life = 7 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $4,660,000 / 7
Annual Depreciation = $665,714.2857

Variable Costs = 28% * Sales
Variable Costs = 28% * $9,320,000
Variable Costs = $2,609,600

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $2,609,600 + $89,000
Pretax Operating Costs = $2,698,600

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$2,698,600 * (1 - 0.35) + 0.35 * $665,714.2857
Annual OCF = -$1,521,090

NPV = -$4,660,000 - $1,521,090 * PVIFA(10%, 7)
NPV = -$4,660,000 - $1,521,090 * 4.868419
NPV = -$12,065,303.45671

EAC = NPV / PVIFA(10%, 7)
EAC = -$12,065,303.45671 / 4.868419
EAC = -$2,478,279.63