Question
In: Finance
Vandelay Industries is considering the purchase of a new machine for the production of latex. Machine...
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Vandelay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,320,000 and will last for six years. Variable costs are 38 percent of sales, and fixed costs are $460,000 per year. Machine B costs $5,598,000 and will last for nine years. Variable costs for this machine are 33 percent of sales and fixed costs are $295,000 per year. The sales for each machine will be $13.5 million per year. The required return is 8 percent, and the tax rate is 25 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. |
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Calculate the EAC for each machine. |
Solutions
Expert Solution
Machine A
| Time line | 0 | 1 | 2 | 3 | 4 | 5 | 6 | |||
| Cost of new machine | -3320000 | |||||||||
| =Initial Investment outlay | -3320000 | |||||||||
| 100.00% | ||||||||||
| Sales | 13500000 | 13500000 | 13500000 | 13500000 | 13500000 | 13500000 | ||||
| Profits | Sales-variable cost | 9720000 | 9720000 | 9720000 | 9720000 | 9720000 | 9720000 | |||
| Fixed cost | -460000 | -460000 | -460000 | -460000 | -460000 | -460000 | ||||
| -Depreciation | Cost of equipment/no. of years | -553333.333 | -553333.333 | -553333.333 | -553333.3 | -553333.3 | -553333.3 | -4.6566E-10 | =Salvage Value | |
| =Pretax cash flows | 8706666.667 | 8706666.667 | 8706666.667 | 8706666.7 | 8706666.7 | 8706666.7 | ||||
| -taxes | =(Pretax cash flows)*(1-tax) | 6530000 | 6530000 | 6530000 | 6530000 | 6530000 | 6530000 | |||
| +Depreciation | 553333.3333 | 553333.3333 | 553333.3333 | 553333.33 | 553333.33 | 553333.33 | ||||
| =after tax operating cash flow | 7083333.33 | 7083333.33 | 7083333.33 | 7083333.3 | 7083333.3 | 7083333.3 | ||||
| +Tax shield on salvage book value | =Salvage value * tax rate | -1.16E-10 | ||||||||
| =Terminal year after tax cash flows | 0 | |||||||||
| Total Cash flow for the period | -3320000 | 7083333.33 | 7083333.33 | 7083333.33 | 7083333.3 | 7083333.3 | 7083333.3 | |||
| Discount factor= | (1+discount rate)^corresponding period | 1 | 1.08 | 1.1664 | 1.259712 | 1.360489 | 1.4693281 | 1.5868743 | ||
| Discounted CF= | Cashflow/discount factor | -3320000 | 6558641.972 | 6072816.641 | 5622978.371 | 5206461.5 | 4820797.6 | 4463701.5 | ||
| NPV= | Sum of discounted CF= | 29425397.60 | ||||||||
| Year or period | 0 | 1 | 2 | 3 | 4 | 5 | 6 | |
| EAC | 6365166.247 | 6365166.247 | 6365166.247 | 6365166.2 | 6365166.2 | 6365166.2 | ||
| Discount factor= | (1+discount rate)^corresponding period | 1.08 | 1.1664 | 1.259712 | 1.360489 | 1.4693281 | 1.5868743 | |
| Discounted CF= | Cashflow/discount factor | 5893672.451 | 5457104.121 | 5052874.186 | 4678587.2 | 4332025.2 | 4011134.4 | |
| NPV= | 29425397.6 | |||||||
| EAC is equivalent yearly CF with same NPV = | 6365166.25 | |||||||
Machine B
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