Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,170,000 and will last for 8 years. Variable costs are 40 percent of sales, and fixed costs are $165,000 per year. Machine B costs $4,370,000 and will last for 12 years. Variable costs for this machine are 32 percent of sales and fixed costs are $100,000 per year. The sales for each machine will be $8.74 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.)

a.

$-4,677,448.12

$2,989,533.98

$-2,691,466.02

$-4,231,976.88

$-14,358,772.57

(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.)

$-8,550,571.5

$-16,331,174.8

$3,284,182.65

$-7,736,231.36

$-2,396,817.35

Answer 1

The annual Cost calculation for both Machines is shown in table below

		Annual Cost Calculation($)
			Machine A	Machine B
		Sales	8740000.00	8740000.00
		Variable Cost	3496000.00	2796800.00
		Fixed Cost	165000.00	100000.00
		Depreciation	271250.00	364166.67
		Cost before tax	3932250.00	3260966.67
		Less: Tax @35%	1376287.50	1141338.33
		After tax cost	2555962.50	2119628.33
		less: Depreciation	271250.00	364166.67
		Free Cash flows	2284712.50	1755461.67

a) EAC of machine A (X) is given by

X/0.1*(1-1/1.1^8) = -2170000 - 2284712.50/0.1*(1-1/1.1^8)

=> X = -2170000*0.1/(1-1/1.1^8) - 2284712.50 = -$2691466.02 (3rd option)

b)

EAC of machine B (X) is given by

X/0.1*(1-1/1.1^12) = -4370000 - 1755461.67/0.1*(1-1/1.1^12)

=> X = -4370000*0.1/(1-1/1.1^12) - 1755461.67 = -$2396817.36 (last option)