Vandalay Industries is considering the purchase of a new machine for the product
ID: 2651141 • Letter: V
Question
Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,830,000 and will last for 5 years. Variable costs are 37 percent of sales, and fixed costs are $152,000 per year. Machine B costs $4,440,000 and will last for 7 years. Variable costs for this machine are 27 percent of sales and fixed costs are $122,000 per year. The sales for each machine will be $8.88 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.
If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine A and B? (Do not round your intermediate calculations.) HINT: In EAC problems you first need to find the NPV of the project. Then calculate the annuity (annual cost) that has the same present value as that NPV.
Required:Explanation / Answer
Machine A
Annual cash Flow = (Sale - Variable Cost - Fixed Cost)*(1-tax rate) + annual depreciation *tax rate
Annual cash Flow = (8880000 - 8880000*37%-152000 )*(1-35%)+1830000/5*35%
Annual cash Flow = 3665660
NPV = -Initial Investment + Annual cash Flow *PVIFA(rate,nper)
NPV = -1830000 +3665660*PVIFA(10%,5)
NPV = -1830000 +3665660*3.79078677
NPV = 12,065,735.43
Equivalent Annual Benefiet = NPV/PVIFA(10%,5)
Equivalent Annual Benefiet = 12065735.43/3.79078677
Equivalent Annual Benefiet = $ 3,182,910.61
Machine B
Annual cash Flow = (Sale - Variable Cost - Fixed Cost)*(1-tax rate) + annual depreciation *tax rate
Annual cash Flow = (8880000 - 8880000*27%-122000 )*(1-35%)+4440000/7*35%
Annual cash Flow = 4356260
NPV = -Initial Investment + Annual cash Flow *PVIFA(rate,nper)
NPV = -4440000 +4356260*PVIFA(10%,7)
NPV = -4440000 +4356260*4.86841882
NPV = 16,768,098.17
Equivalent Annual Benefiet = NPV/PVIFA(10%,5)
Equivalent Annual Benefiet = 16768098.17/4.86841882
Equivalent Annual Benefiet = $ 3,444,259.58
Decision: Choose Machine B as it would produce more Equivalent Annual Benefiet than machine A
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