Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,810,000 and will last for 4 years. Variable costs are 34 percent of sales, and fixed costs are $147,000 per year. Machine B costs $4,380,000 and will last for 7 years. Variable costs for this machine are 30 percent of sales and fixed costs are $77,000 per year. The sales for each machine will be $8.76 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)$-7,747,585.91$-2,444,137.15$-3,498,978.25$3,249,862.85$-3,867,291.75

  

(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.)

Answer 1

Ans:

(a) EAC for machine A

Depreciation under SLM

= (Cost of asset - salvage value) / useful life

= ($1,810,000 - $0) / 4

= $ 452,500

Here, expected net cash flows during each of the 4 years of useful life of machine A

= (Expected annual sales - variable costs - fixed costs) * (1 - income tax rate) + annual depreciation (i.e. non-cash expense)

= ($8.76 million - 34 % * $8.76 million - $147,000) * (1 - 35%) + $452,500

= 4,114,990

Now, the EAC for the machine A

=$1,810,000- ($4,114,990/(1.10)+$ 4,114,990/( 1.10)^2+....+$4,114,990/(1.10)^4)

= $ 1,810,000 – 13,043,965

=−$ 11,233,965

(b) EAC for machine B

Annual depreciation for machine B using straight-line method

= (Cost of asset - salvage value) / useful life

= ($4,380,000 - $0) / 7

= $625,714.3

Here, expected net cash flows during each of the 7 years of useful life of machine B

= (Expected annual sales - variable costs - fixed costs) * (1 - income tax rate) + annual depreciation (i.e. non-cash expense)

= ($8.76 million - 30 % * $8.76 million - $77,000) * (1 - 35%) + $625,714.3

= $ 3,935,750 + $ 625,714.3

= $ 4,561,464

Now, the EAC for the machine B

=$4,380,000−($4,561,464/(1.10)+4,561,464/(1.10)^2+....+$4,561,464/(1.10)^7)

=$4,380,000 - $ 22,207,119

=− $ 17,827,119