Vandalay Industries is considering the purchase of a new machine for the product
ID: 2801396 • 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 6 years. Variable costs are 34 percent of sales, and fixed costs are $141,000 per year. Machine B costs $4,570,000 and will last for 9 years. Variable costs for this machine are 27 percent of sales and fixed costs are $129,000 per year. The sales for each machine will be $9.14 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? (Do not round your intermediate calculations.)
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.)
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 6 years. Variable costs are 34 percent of sales, and fixed costs are $141,000 per year. Machine B costs $4,570,000 and will last for 9 years. Variable costs for this machine are 27 percent of sales and fixed costs are $129,000 per year. The sales for each machine will be $9.14 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.
Explanation / Answer
Machine A Machine B Cost 1880000 4570000 Useful life 6 9 Variable Cost 34%of sales 27% of sales FixedCost 141000 129000 Dep (Cost/useful life) 313333.3333 507777.8 Sales 9140000 9140000 VC (% of sales) 3107600 2467800 Tax Rate 35% R 10% Since we need to calculate the EAC for each machine, sales are irrelevant. EAConly uses the costs of operating the equipment, not the sales. Using the bottom-upapproach, or net income plus depreciation, method to calculate OCF, we get Machine A Machine B Variable Cost -3107600 -2467800 FixedCost -141000 -129000 Depreciation -313333.3333 -507777.8 EBT -3561933.333 -3104578 Tax@35% 1246676.667 1086602 Net Income -2315256.667 -2017976 Add: Depreciation 313333.3333 507777.8 OCF -2001923.333 -1510198 The NPV and EAC for Machine A are NPVA= $1880000 $2001923.33(PVIFA10%,6) NPVA= $1880000 $2001923.33*4.35526 (10,598,897) EAC A = NPVA/(PVIFA10%,6) =-10598897/4.35526 (2,433,585) $ The NPV and EAC for Machine B are NPVB= $4570000 $1510198(PVIFA10%,9) NPVB= $4570000 $1510198-5.759 (6,080,192) $ EAC B = NPVB/(PVIFA10%,9) =-6080192/5.7590 (1,055,772.18) $ You should choose Machine B since it has a more positive EAC
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