Vandalay Industries is considering the purchase of a new machine for the product
ID: 2745360 • Letter: V
Question
Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,100,000 and will last for 6 years. Variable costs are 35 percent of sales, and fixed costs are $204,000 per year. Machine B costs $6,100,000 and will last for 9 years. Variable costs for this machine are 30 percent of sales and fixed costs are $165,000 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
Requirement a:
Net Present Value of Machine A:
Initial Cash Flow:
Purchase Cost -$3100000
Depreciation = 3100000 / 6 = $516667
Cash Flow after Tax:
Particulars
Amount
Sales
$8860000
Less: Variable Costs (8860000 * 0.35)
-$3101000
Contribution
$5759000
Less: Fixed Costs
-$204000
Net Profit
$5555000
Less: Taxes
-$1944250
Net Profit After Taxes
$3610750
Add: Depreciation
$516667
Cash Flow After Tax
$4127417
PV of Cash Inflows = $4127417 * PVAF (10%, 6)
= $4127417 * 4.355
= $1,79,74,901
NPV = PV of Cash Inflows – PV of Cash outflows
= $17974901 - $3100000
= $14874901
EAC = NPV / Annuity factor
= $14874901 / 4.355
= $34,15,591
Requirement b:
Net Present Value of Machine B:
Initial Cash Flow:
Purchase Cost -$6100000
Depreciation = 6100000 / 9 = $677778
Cash Flow after Tax:
Particulars
Amount
Sales
$8860000
Less: Variable Costs (8860000 * 0.30)
-$2658000
Contribution
$6202000
Less: Fixed Costs
-$165000
Net Profit
$6037000
Less: Taxes
-$2112950
Net Profit After Taxes
$3924050
Add: Depreciation
$677778
Cash Flow After Tax
$4601828
PV of Cash Inflows = $4601828 * PVAF (10%, 9)
= $4601828 * 5.759
= $26501927.452
NPV = PV of Cash Inflows – PV of Cash outflows
= $26501927.452 - $6100000
= $20401927.452
EAC = NPV / Annuity factor
= $20401927.452 / 5.759
= $35,42,616.3313
Particulars
Amount
Sales
$8860000
Less: Variable Costs (8860000 * 0.35)
-$3101000
Contribution
$5759000
Less: Fixed Costs
-$204000
Net Profit
$5555000
Less: Taxes
-$1944250
Net Profit After Taxes
$3610750
Add: Depreciation
$516667
Cash Flow After Tax
$4127417
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