Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,400,000 and will last for 5 years. Variable costs are 33 percent of sales, and fixed costs are $180,000 per year. Machine B costs $4,450,000 and will last for 7 years. Variable costs for this machine are 26 percent of sales and fixed costs are $91,000 per year. The sales for each machine will be $8.9 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)$-4,045,147.5$-9,443,471.36$-2,491,163.95$3,293,836.05$-4,470,952.5

  

(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

a

Time line		0	1	2	3	4	5
Cost of new machine		-2400000
=Initial Investment outlay		-2400000
Sales			8900000	8900000	8900000	8900000	8900000
Profits	Sales-variable cost		5963000	5963000	5963000	5963000	5963000
Fixed cost			-180000	-180000	-180000	-180000	-180000
-Depreciation	Cost of equipment/no. of years		-480000	-480000	-480000	-480000	-480000
=Pretax cash flows			5303000	5303000	5303000	5303000	5303000
-taxes	=(Pretax cash flows)*(1-tax)		3446950	3446950	3446950	3446950	3446950
+Depreciation			480000	480000	480000	480000	480000
=after tax operating cash flow			3926950	3926950	3926950	3926950	3926950
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							0
Total Cash flow for the period		-2400000	3926950	3926950	3926950	3926950	3926950
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331	1.4641	1.61051
Discounted CF=	Cashflow/discount factor	-2400000	3569954.545	3245413.2	2950375.7	2682159.7	2438327
NPV=	Sum of discounted CF=	12486230.1

EAC	3293836.046
Year or period		0	1	2	3	4	5
EAC			3293836.046	3293836	3293836	3293836	3293836
Discount factor=	(1+discount rate)^corresponding period		1.1	1.21	1.331	1.4641	1.61051
Discounted CF=	Cashflow/discount factor		2994396.406	2722178.6	2474707.8	2249734.3	2045213
NPV=	12486230.1
EAC is equivalent yearly CF with same NPV =	3293836.046

b

Time line		0	1	2	3	4	5	6	7
Cost of new machine		-4450000
=Initial Investment outlay		-4450000
Sales			8900000	8900000	8900000	8900000	8900000	8900000	8900000
Profits	Sales-variable cost		6586000	6586000	6586000	6586000	6586000	6586000	6586000
Fixed cost			-91000	-91000	-91000	-91000	-91000	-91000	-91000
-Depreciation	Cost of equipment/no. of years		-635714.286	-635714.3	-635714.3	-635714.3	-635714.3	-635714.3	-635714.286
=Pretax cash flows			5859285.714	5859285.7	5859285.7	5859285.7	5859285.7	5859285.7	5859285.714
-taxes	=(Pretax cash flows)*(1-tax)		3808535.714	3808535.7	3808535.7	3808535.7	3808535.7	3808535.7	3808535.714
+Depreciation			635714.2857	635714.29	635714.29	635714.29	635714.29	635714.29	635714.2857
=after tax operating cash flow			4444250	4444250	4444250	4444250	4444250	4444250	4444250
+Tax shield on salvage book value	=Salvage value * tax rate								3.25963E-10
=Terminal year after tax cash flows									3.25963E-10
Total Cash flow for the period		-4450000	4444250	4444250	4444250	4444250	4444250	4444250	4444250
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331	1.4641	1.61051	1.771561	1.9487171
Discounted CF=	Cashflow/discount factor	-4450000	4040227.273	3672933.9	3339030.8	3035482.5	2759529.6	2508663.3	2280602.967
NPV=	Sum of discounted CF=	17186470.33

EAC	3530195.526
Year or period		0	1	2	3	4	5	6	7
EAC			3530195.526	3530195.5	3530195.5	3530195.5	3530195.5	3530195.5	3530195.526
Discount factor=	(1+discount rate)^corresponding period		1.1	1.21	1.331	1.4641	1.61051	1.771561	1.9487171
Discounted CF=	Cashflow/discount factor		3209268.66	2917517	2652288.1	2411171	2191973.7	1992703.3	1811548.493
NPV=	17186470.33
EAC is equivalent yearly CF with same NPV =	3530195.526