Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,340,000 and will last for 8 years. Variable costs are 38 percent of sales, and fixed costs are $150,000 per year. Machine B costs $4,510,000 and will last for 10 years. Variable costs for this machine are 27 percent of sales and fixed costs are $120,000 per year. The sales for each machine will be $9.02 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.)

A) $3,201,316 B) $-2,661,684 C)$-4,791,218.25 D)$-4,334,911.75 E)$-14,199,887.71

(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.)

A) $-2,237,141.73 B) $-6,962,250.94 C) $3,625,858.27 D) $-13,746,267.49 E) $-6,299,179.42

Answer 1

Machine A:

Cost of Machine = $2,340,000
Useful Life = 8 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $2,340,000 / 8
Annual Depreciation = $292,500

Variable Costs = 38% * Sales
Variable Costs = 38% * $9,020,000
Variable Costs = $3,427,600

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $3,427,600 + $150,000
Pretax Operating Costs = $3,577,600

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$3,577,600 * (1 - 0.35) + 0.35 * $292,500
Annual OCF = -$2,223,065

NPV = -$2,340,000 - $2,223,065 * PVIFA(10%, 8)
NPV = -$2,340,000 - $2,223,065 * 5.33493
NPV = -$14,199,896.16

EAC = NPV / PVIFA(10%, 8)
EAC = -$14,199,896.16 / 5.33493
EAC = -$2,661,684

Machine B:

Cost of Machine = $4,510,000
Useful Life = 10 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $4,510,000 / 10
Annual Depreciation = $451,000

Variable Costs = 27% * Sales
Variable Costs = 27% * $9,020,000
Variable Costs = $2,435,400

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $2,435,400 + $120,000
Pretax Operating Costs = $2,555,400

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$2,555,400 * (1 - 0.35) + 0.35 * $451,000
Annual OCF = -$1,503,160

NPV = -$4,510,000 - $1,503,160 * PVIFA(10%, 10)
NPV = -$4,510,000 - $1,503,160 * 6.14457
NPV = -$13,746,271.84

EAC = NPV / PVIFA(10%, 10)
EAC = -$13,746,271.84 / 6.14457
EAC = -$2,237,141.73