Vandalay Industries is considering the purchase of a new machine for the product
ID: 2715012 • 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?
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?
Explanation / Answer
Answer: Since we need to calculate the EAC for each machine, sales are irrelevant. EAC only uses the costs of operating the equipment, not the sales. Using the bottom up approach, or net income plus depreciation, method to calculate OCF, we get:
The NPV and EAC for Machine A is:
NPVA = –$1,940,000 – $2,478950(PVIFA10%,7)
NPVA = –$14008520.18
EACA = – $14008520.18 / (PVIFA10%,7)
EACA = –$2877438.21
And the NPV and EAC for Machine B is:
NPVB = –$4760,000 – 1635136(PVIFA10%,11)
NPVB = –$15380371.83
EACB = – $15380371.83/ (PVIFA10%,11)
EACB = –$2367996.156
You should choose Machine B since it has a more positive EAC .
Particulars Machine A Machine B Variable cost -3808000 -2665600 Fixed cost -155000 -83000 Depreciation -277143 -432727 EBT -4240143 -3181327 Tax 1484050.1 1113464.5 Net income -2756093 -2067863 Add: Dep 277143 432727 OCF -2478950 -1635136Related Questions
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