Vandalay Industries is considering the purchase of a new machine for the product
ID: 2615120 • Letter: V
Question
Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,880,000 and will last for 4 years. Variable costs are 36 percent of sales, and fixed costs are $153,000 per year. Machine B costs $4,310,000 and will last for 7 years. Variable costs for this machine are 28 percent of sales and fixed costs are $93,000 per year. The sales for each machine will be $8.62 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? (b) If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine B?
Explanation / Answer
Machine A
Cost of Machine A = $1,880,000
Life of machine A = 4 years
Annual depreciation = Cost of machine/ Life of machine
Annual depreciation of machine A = 1,880,000/4
= $470,000
Calculation of annual cash inflows
Present value of cash inflows = Annual cash flows after tax x PVAF(10% , 4 )
= 3,650,970 x 3.170
= $11,573,575
NPV of machine A = Present value of cash inflows - Present value of cash outflows
= 11,573,575 - 1,880,000
= $ 9,693,575
EAC of machine A = NPV of a project/PVAF(10%, 4 )
= 9,693,575/3.170
= $3,057,910
Machine b
Cost of Machine B = $4,310,000
Life of machine B = 7 years
Annual depreciation = Cost of machine/ Life of machine
Annual depreciation of machine B = 4,310,000/7
= $615,714
Calculation of annual cash inflows
Present value of cash inflows = Annual cash flows after tax x PVAF(10% , 7 )
= 4,189,210 x 4.868
= $20,393,074
NPV of machine B = Present value of cash inflows - Present value of cash outflows
= 20,393,074 - 4,310,000
= $16,083,074
EAC of machine B = NPV of a project/PVAF(10%, 7)
= 16,083,074/4.868
= $3,303,836
Sales 8,620,000 Less: Variable cost @ 36% - 3,103,200 Contribution 5,516,800 Less: Fixed cost - 153,000 EBIT 5,363,800 Less: Depreciation - 470,000 Earnings before tax 4,893,800 Less : Tax @ 35% - 1,712,830 Earnings after tax 3,180,970 Add : Depreciation 470,000 Annual cash flows after tax 3,650,970Related Questions
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