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Vandelay Industries is considering the purchase of a new machine for the production of latex. Machine...

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.

Calculate the EAC for each machine.

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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

jeff jeffy answered 1 year ago
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