Question

Chocoholics Anonymous wants to modernize its production machinery. The company's sales are $8.88 million per year, and the choice of machine won't impact that amount. The required return is 10 percent and the tax rate is 35 percent. Both machines will be depreciated on a straight-line basis. Machine Amaretto costs $2,330,000 and will last for 6 years. Variable costs are 40 percent of sales, and fixed costs are $161,000 per year. Machine Baileys costs $4,440,000 and will last for 10 years. Variable costs for this machine are 26 percent of sales and fixed costs are $87,000 per year.

  

Required:

(a)	If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine Amaretto? (Do not round your intermediate calculations.)
	HINT: In EAC problems you first need to find the NPV. Using this NPV you can then calculate the annuity (annual cost) that has the same present value/cost. The lecture videos include a detailed example of this calculation.
	(Click to select)$-4,377,156.67$-12,249,251.42$-4,837,910$2,959,481.47$-2,812,518.53

  

(b)	If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine Baileys? (Do not round your intermediate calculations.)

Answer 1

Solution:

a) If the Company Plans to Replace the Machine when it wears Out on a Perpetual Basis, then Calculation of the EAC for Machine Amaretto:

Particulars	Amaretto
Variable Costs ($8,880,000 * 40%)	-$3,552,000
Fixed Costs	-$161,000
Depreciation ($2,330,000/6 Yrs)	-$388,333
EBT	-$4,101,333
Tax (35%)	$1,435,467
Net Income	-$2,665,866
Add: Depreciation	$388,333
OCF	-$2,277,533

Therefore, the EAC for machine Amaretto is -$2,12,513.37.

b) If the Company Plans to Replace the Machine when it wears Out on a Perpetual Basis, then Calculation of the EAC for Machine Baileys:

Particulars	Baileys
Variable Costs ($8,880,000 * 26%)	-$2,308,800
Fixed Costs	-$87,000
Depreciation ($4,440,000/10 Yrs)	-$444,000
EBT	-$2,839,800
Tax (35%)	$993,930
Net Income	-$1,845,870
Add: Depreciation	$444,000
OCF	-$1,401,870

Therefore, the EAC for machine Baileys is -$2,124,455.68.