Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,140,000 and will last for 7 years. Variable costs are 33 percent of sales, and fixed costs are $175,000 per year. Machine B costs $4,220,000 and will last for 10 years. Variable costs for this machine are 30 percent of sales and fixed costs are $108,000 per year. The sales for each machine will be $8.44 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.)

Answer 1

EAC:
		Machine A	Machine B
Annual Sales		8440000	8440000
Less: Variable cost		2785200	2532000
Less: Fixed cost		175000	108000
Less: Depreciation		214000	422000
		(2140000/7)	(4220000/10)
Before tax Income		5265800	5378000
Less: Tax @ 35%		1843030	1882300
After tax income		3422770	3495700
Add: Dep		214000	422000
Annual cashflows		3636770	3917700
Multiply: Annuity PVF		4.86842	6.14457
Present value of inflows		17705323.8	24072581.9
Less: Investment		2140000	4220000
NPV		15565323.8	19852581.9
Divide: Annuity PVF		4.86842	6.14457
Equivalent AC		3197202.34	3230914.76