Question

andelay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,300,000 and will last for six years. Variable costs are 40 percent of sales, and fixed costs are $440,000 per year. Machine B costs $5,572,000 and will last for nine years. Variable costs for this machine are 35 percent of sales and fixed costs are $285,000 per year. The sales for each machine will be $13.3 million per year. The required return is 10 percent, and the tax rate is 23 percent. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis. Calculate the EAC for each machine. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) find System A System B

Answer 1

Machine A:

Cost of Machine = $3,300,000
Useful Life = 6 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $3,300,000 / 6
Annual Depreciation = $550,000

Variable Costs = 40% * Sales
Variable Costs = 40% * $13,300,000
Variable Costs = $5,320,000

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $5,320,000 + $440,000
Pretax Operating Costs = $5,760,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$5,760,000 * (1 - 0.23) + 0.23 * $550,000
Annual OCF = -$4,308,700

NPV = -$3,330,000 - $4,308,700 * PVIFA(10%, 6)
NPV = -$3,330,000 - $4,308,700 * 4.35526
NPV = -$22,095,508.762

EAC = NPV / PVIFA(10%, 6)
EAC = -$22,095,508.762 / 4.35526
EAC = -$5,073,292.70

Machine B:

Cost of Machine = $5,572,000
Useful Life = 9 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $5,572,000 / 9
Annual Depreciation = $619,111.11

Variable Costs = 35% * Sales
Variable Costs = 35% * $13,300,000
Variable Costs = $4,655,000

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $4,655,000 + $285,000
Pretax Operating Costs = $4,940,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$4,940,000 * (1 - 0.23) + 0.23 * $619,111.11
Annual OCF = -$3,661,404.445

NPV = -$5,572,000 - $3,661,404.445 * PVIFA(10%, 9)
NPV = -$5,572,000 - $3,661,404.445 * 5.75902
NPV = -$26,658,101.427

EAC = NPV / PVIFA(10%, 9)
EAC = -$26,658,101.427 / 5.75902
EAC = -$4,628,930.17

Machine B should be preferred.