Vandalay Industries is considering the purchase of a new machine for the product

Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,350,000 and will last for 8 years. Variable costs are 39 percent of sales, and fixed costs are $169,000 per year. Machine B costs $4,430,000 and will last for 11 years. Variable costs for this machine are 32 percent of sales and fixed costs are $97,000 per year. The sales for each machine will be $8.86 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.) (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.)

Explanation / Answer

Calculation of NPV of Machine A Cash Inflow (For 1-8 Years) Sales          8,860,000.00 Less: Expenses Variable Cost (39% of Sales)          3,455,400.00 Fixed Costs              169,000.00 Depreciation on Machine              293,750.00 ($2350000 / 8 Years) Total Expenes          3,918,150.00 Net Income Before Tax          4,941,850.00 Less Income Tax (35% of Net Income)          1,729,647.50 Net Income After Tax          3,212,202.50 Cash Inflow          3,505,952.50 (Net Income After Tax + Dep. PV Factor @10%                      2.1436 A. PV OF Cash Inflow          7,515,359.78 Cash outflow B. Machine purchased          2,350,000.00 NPV of Machine A (A-B)          5,165,359.78 EAC for Machine A = PV oF Cost/ Annuity Factor                                        =5165359.78/2.1436 = $2409665.88 Calculation of NPV of Machine B Cash Inflow (For 1-11 Years) Sales          8,860,000.00 Less: Expenses Variable Cost (32% of Sales)          2,835,200.00 Fixed Costs                97,000.00 Depreciation on Machine              402,727.27 ($4430000 /11 Years) Total Expenes          3,334,927.27 Net Income Before Tax          5,525,072.73 Less Income Tax (35% of Net Income)          1,933,775.45 Net Income After Tax          3,591,297.27 Cash Inflow          3,994,024.55 (Net Income After Tax + Dep. PV Factor @10%                      2.8531 A. PV OF Cash Inflow        11,395,351.72 Cash outflow B. Machine purchased          4,430,000.00 NPV of Machine A (A-B)          6,965,351.72 EAC for Machine B = PV oF Cost/ Annuity Factor                                        =6965351.72/2.8531 = $2441327.58

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