Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,200,000 and will last for 7 years. Variable costs are 35 percent of sales, and fixed costs are $154,000 per year. Machine B costs $4,630,000 and will last for 10 years. Variable costs for this machine are 27 percent of sales and fixed costs are $127,000 per year. The sales for each machine will be $9.26 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.

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.)

Answer 1

EAC only calculates the costs of operating the equipment,not the sales.

	Machine A	Machine B
Variable Costs	-3,241,000	-2,500,200
Fixed Costs	- 154,000	- 127,000
Depreciation	- 314,286	- 463,000
EBT	-3,709,286	-3,090,200
Tax	1,298,520	1,081,570
Net Income	-2,411,036	-2,008,630
Depreciation	314,286	463,000
OCF	-2,096,750	-2,471,630

a). NPV(A) = -$2,200,000 - $2,096,750[PVIFA(10%,7)]

= -$2,200,000 - $10,207,817.70 = -$12,407,817.70

EAC(A) = -$12,407,817.70 / (PVIFA10%,7)

= -$12,407,817.70 / 4.8684 = -$2,548,643.85

b). NPV(A) = -$4,630,000 - $2,471,630[PVIFA(10%,10)]

= -$4,630,000 - $15,187,177.70 = -$19,817,177.70

EAC(A) = -$19,817,177.70 / (PVIFA10%,7)

= -$19,817,177.70 / 6.1446 = -$3,225,137.14