In: Finance
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.) |
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
|
|||||||
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
|
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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 |