Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,360,000 and will last for 4 years. Variable costs are 35 percent of sales, and fixed costs are $130,000 per year. Machine B costs $4,580,000 and will last for 6 years. Variable costs for this machine are 32 percent of sales and fixed costs are $98,000 per year. The sales for each machine will be $9.16 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:

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.)

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

	A	B
Investment	-2,360,000	-4,580,000
Sales	9,160,000	9,160,000
VC	-3,206,000	-2,931,200
FC	-130,000	-98,000
Depreciation	-590,000	-763,333
EBT	5,234,000	5,367,467
Tax (35%)	-1,831,900	-1,878,613
Net Profit	3,402,100	3,488,853
FCF	3,992,100	4,252,187
NPV	$10,294,419.85	$13,939,381.48
EAC	$3,247,588.90	$4,397,467.88

Firstly, we need to find out Free Cash Flow (FCF) from each machine given the sales and costs.

Depreciation = Investment / No. of years

FCF = Net Profit + Depreciation

Secondly, we need to find NPV of both machines using PV function on a calculator or excel

For A, N = 4, I/Y = 10%, PMT = 3,992,100, FV = 0 => Compute PV = $12,654,419.85

NPV = 12,654,419.85 - 2,360,000 = $10,294,419.85 and so on for B

Now, EAC can be calculated using PMT function

For A, N = 4, I/Y = 10%, PV = 10,294,419.5, FV = 0 => Compute PMT = $3,247,588.90 and so on for B.