Question

In: Finance

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine...

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,850,000 and will last for 4 years. Variable costs are 39 percent of sales, and fixed costs are $123,000 per year. Machine B costs $4,420,000 and will last for 7 years. Variable costs for this machine are 29 percent of sales and fixed costs are $124,000 per year. The sales for each machine will be $8.84 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.

(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.)

(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.)

Solutions

Expert Solution

a)

Time line 0 1 2 3 4
Cost of new machine -1850000
=Initial Investment outlay -1850000
Sales 8840000 8840000 8840000 8840000
Profits Sales-variable cost 5392400 5392400 5392400 5392400
Fixed cost -123000 -123000 -123000 -123000
-Depreciation Cost of equipment/no. of years -462500 -462500 -462500 -462500
=Pretax cash flows 4806900 4806900 4806900 4806900
-taxes =(Pretax cash flows)*(1-tax) 3124485 3124485 3124485 3124485
+Depreciation 462500 462500 462500 462500
=after tax operating cash flow 3586985 3586985 3586985 3586985
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 0
Total Cash flow for the period -1850000 3586985 3586985 3586985 3586985
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331 1.4641
Discounted CF= Cashflow/discount factor -1850000 3260895.5 2964450.41 2694954.9 2449959
NPV= Sum of discounted CF= 9520259.81

IRR

False False Center Center
0
EAC 3003364.013
Year or period 0 1 2 3 4
EAC 3003364 3003364.01 3003364 3003364
Discount factor= (1+discount rate)^corresponding period 1.1 1.21 1.331 1.4641
Discounted CF= Cashflow/discount factor 2730330.9 2482119.02 2256471.8 2051338
NPV= 9520259.808
EAC is equivalent yearly CF with same NPV = 3003364.013

b)

Time line 0 1 2 3 4 5 6 7
Cost of new machine -4420000
=Initial Investment outlay -4420000
Sales 8840000 8840000 8840000 8840000 8840000 8840000 8840000
Profits Sales-variable cost 6276400 6276400 6276400 6276400 6276400 6276400 6276400
Fixed cost -124000 -124000 -124000 -124000 -124000 -124000 -124000
-Depreciation Cost of equipment/no. of years -631428.6 -631428.57 -631428.6 -631428.6 -631429 -631428.6 -631429
=Pretax cash flows 5520971.4 5520971.43 5520971.4 5520971.4 5520971 5520971.4 5520971
-taxes =(Pretax cash flows)*(1-tax) 3588631.4 3588631.43 3588631.4 3588631.4 3588631 3588631.4 3588631
+Depreciation 631428.57 631428.571 631428.57 631428.57 631428.6 631428.57 631428.6
=after tax operating cash flow 4220060 4220060 4220060 4220060 4220060 4220060 4220060
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 0
Total Cash flow for the period -4420000 4220060 4220060 4220060 4220060 4220060 4220060 4220060
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331 1.4641 1.61051 1.771561 1.948717
Discounted CF= Cashflow/discount factor -4420000 3836418.2 3487652.89 3170593.5 2882357.8 2620325 2382113.9 2165558
NPV= Sum of discounted CF= 16125019.5

IRR

False False Center Center
0
EAC 3312167.691
Year or period 0 1 2 3 4 5 6 7
EAC 3312167.7 3312167.69 3312167.7 3312167.7 3312168 3312167.7 3312168
Discount factor= (1+discount rate)^corresponding period 1.1 1.21 1.331 1.4641 1.61051 1.771561 1.948717
Discounted CF= Cashflow/discount factor 3011061.5 2737328.67 2488480.6 2262255.1 2056596 1869632.3 1699666
NPV= 16125019.52
EAC is equivalent yearly CF with same NPV = 3312167.691

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