Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,030,000 and will last for 4 years. Variable costs are 38 percent of sales, and fixed costs are $162,000 per year. Machine B costs $4,770,000 and will last for 7 years. Variable costs for this machine are 28 percent of sales and fixed costs are $90,000 per year. The sales for each machine will be $9.54 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?

(b)	If the company plans to replace the machine when it wears out on a perpetual basis, what is the EAC for machine B?

Answer 1

For Calculation EAC , it includes only operating costs.Sales are not considered while calculating EAC.

	Machine A	Machine B
Variable cost	(9540000*0.38) =(3625200)	(9540000*0.28) =(2671200)
fixed cost	(162,000)	(90,000 )
Depreciation	(507500)	(681429)
Earning before tax	(4294700)	(3442629)
tax	1503145	1204920
Net income	(2791555)	(2237709)
Add: Deprecation	507500	681429
Operating cash flow	(2284055)	(1556280)
NPV (present value of cash inflow-present value of cash outflow)	(2284055)*PVIFA(10%,4) - 2030000 =(9270226)	(1556280) * PVIFA(10%,7) - 4,770,000 = (12346594)
EAC [NPV / PVIFA]	(9270226) / PVIFA(10%,4) = (2924454)	(12346594) / PVIFA(10%,7) = (2536068)

a.) EAC for machine A = ($2924454)

b) EAC for machine B = ($2536068)