Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,930,000 and will last for 6 years. Variable costs are 38 percent of sales, and fixed costs are $129,000 per year. Machine B costs $4,210,000 and will last for 10 years. Variable costs for this machine are 30 percent of sales and fixed costs are $130,000 per year. The sales for each machine will be $8.42 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:

(a)	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.)
	(Click to select)$-3,781,956.33$-2,494,148.91$-10,862,668.73$-4,180,057$2,978,851.09

   

(b)	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

Machine A:

Cost of Machine = $1,930,000
Useful Life = 6 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $1,930,000 / 6
Annual Depreciation = $321,666.67

Variable Costs = 38% * Sales
Variable Costs = 38% * $8,420,000
Variable Costs = $3,199,600

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $3,199,600 + $129,000
Pretax Operating Costs = $3,328,600

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$3,328,600 * (1 - 0.35) + 0.35 * $321,666.67
Annual OCF = -$2,051,006.67

NPV = -$1,930,000 - $2,051,006.67 * PVIFA(10%, 6)
NPV = -$1,930,000 - $2,051,006.67 * 4.35526
NPV = -$10,862,667.3096

EAC = NPV / PVIFA(10%, 6)
EAC = -$10,862,667.3096 / 4.35526
EAC = -$2,494,148.91

Machine B:

Cost of Machine = $4,210,000
Useful Life = 10 years

Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $4,210,000 / 10
Annual Depreciation = $421,000

Variable Costs = 30% * Sales
Variable Costs = 30% * $8,420,000
Variable Costs = $2,526,000

Pretax Operating Costs = Variable Costs + Fixed Costs
Pretax Operating Costs = $2,526,000 + $130,000
Pretax Operating Costs = $2,656,000

Annual OCF = Pretax Operating Costs * (1 - tax) + tax * Depreciation
Annual OCF = -$2,656,000 * (1 - 0.35) + 0.35 * $421,000
Annual OCF = -$1,579,050

NPV = -$4,210,000 - $1,579,050 * PVIFA(10%, 10)
NPV = -$4,210,000 - $1,579,050 * 6.14457
NPV = -$13,912,583.2585

EAC = NPV / PVIFA(10%, 10)
EAC = -$13,912,583.2585 / 6.14457
EAC = -$2,264,207.79