Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,400,000 and will last for 6 years. Variable costs are 38 percent of sales, and fixed costs are $175,000 per year. Machine B costs $4,670,000 and will last for 8 years. Variable costs for this machine are 27 percent of sales and fixed costs are $112,000 per year. The sales for each machine will be $9.34 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.)
	Possible choices: $-4,446,693.5 $3,239,212.29 $-4,914,766.5 $-12,333,173.74 $-2,831,787.71

   

(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.)
	Possible choices: $3,687,978.94 $-12,713,241.49 $-6,847,037.47 $-2,383,021.06 $-7,567,778.25

Answer 1

Question - a

Cost of the machine - A ........... 2400,000

Depreciation = 2400.000 / 6 years = 400,000.

Tax savings on depreciation = 400,000 * 0.35 = 140,000

Total cost = Variable cost + Fixed cost = (9340000 * 0.38) + 175,000 = 3549200 + 175,000 = 3724200

Total annual cash out flow after tax = 3724200 * ( 1 - 0.35 ) - 140,000 = 2280730

Equivalent annual cost ( EAC) = Cost of machine / PVIFA + Annual cost after tax

= - 2400,000 / 4.35526070 -  2280730

= - 2,831,787.71

PVIFA = [ 1 - (1.10)^-6 ] / 0.10 = 4.35526070

Question - b

Cost of the machine - B ........... 4,670,000

Depreciation = 4,670,000 / 8 years = 583,750.

Tax savings on depreciation = 583,750* 0.35 = 204,312.5

Total cost = Variable cost + Fixed cost = (9340000 * 0.27) + 175,000 = 2521800+ 112,000= 2633800

Total annual cash out flow after tax = 2633800* ( 1 - 0.35 ) - 204,312.5= 1507657.5

Equivalent annual cost ( EAC) = Cost of machine / PVIFA + Annual cost after tax

= - 4,670,000 / 5.33492620 -  1507657.5

= - 2,383,021.06

PVIFA = [ 1 - (1.10)^-8 ] / 0.10 = 5.33492620