Vandalay Industries is considering the purchase of a new machine for the product
ID: 2714934 • Letter: V
Question
Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,940,000 and will last for 7 years. Variable costs are 40 percent of sales, and fixed costs are $155,000 per year. Machine B costs $4,760,000 and will last for 11 years. Variable costs for this machine are 28 percent of sales and fixed costs are $83,000 per year. The sales for each machine will be $9.52 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?
If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine B?
(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
EAC for Machine A
Cost of machine = $1,940,000
Useful life of machine = 7 years
Annual depreciation = $1,940,000 / 7 = $277,142.86
After tax depreciation cost = $277,142.86 * (1 - 0.35) = $180,143
Annual Variable cost = 40% of sales = $9,520,000 * 40% = $3,808,000
Annual Fixed cost = $155,000
Total annual cost of Machine A = $180,143 + $3,808,000 + $155,000 = $4,143,143
EAC for Machine B
Cost of machine = $4,760,000
Useful life of machine = 11 years
Annual depreciation = $4,760,000 / 11 = $432,727
After tax depreciation cost = $432,727 * (1 - 0.35) = $281,272
Annual Variable cost = 28% of sales = $9,520,000 * 28% = $2,665,600
Annual Fixed cost = $83,000
Total annual cost of Machine B = $281,272 + $2,665,600 + $83,000 = $3,029,872
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