Question 33 1 pts You are considering two machines, A and B that can be used for

Question

Question 33 1 pts You are considering two machines, A and B that can be used for the same purpose. Machine A costs $250,000, will reduce costs by $70,000 per year, needs net working capital of $20,000 at time zero which be released at the end of the project, has a 5 year straight line depreciable life and can be sold at the end of the project's life for $50,000. Machine B costs $320,000, will reduce costs by the same $70.000 per year, has net working capital of $40,000 at time zero (also released at the end of its life), has a ten year straight line depreciable life and can be sold at the end of its life for $60.000. Assume that the tax rate is 34% and the discount rate is 10%. Calculate an Equivalent Annual Cost for each machine. What are they and which machine should you choose? O $234.4 for A and $4,233.4 for B, choose B $507.28 for A and $2.333.1 for B, choose B O $1,705.84 for A and $7,909.22 for B, choose B $7,909.22 for A and $1,705.22 for B, choose A $655.95 for A and $3,486.19 for B, choose B

Explanation / Answer

$ 655.95 for A and $ 3,486.19 for B, choose B

Working:

Machine A: Year 0 1 2 3 4 5 Total Cost of Machine (1) $        -2,50,000 Net Working Capital (2) -20,000 Saving in costs            70,000         70,000        70,000        70,000         70,000 Depreciation Expense          -50,000       -50,000       -50,000       -50,000        -50,000 Profit Before tax            20,000         20,000        20,000        20,000         20,000 Tax Expense             -6,800          -6,800         -6,800         -6,800          -6,800 Net Income            13,200         13,200        13,200        13,200         13,200 Depreciation Expense            50,000         50,000        50,000        50,000         50,000 Operating Cash flow (3)            63,200         63,200        63,200        63,200         63,200 After tax sale price of Machine (4)         33,000 Release of Working capital (5)         20,000 Annual Cash flow (1) + (2) + (3) +(4) +(5) $        -2,70,000 $        63,200 $     63,200 $    63,200 $    63,200 $ 1,16,200 Discount factor 1.000              0.909           0.826           0.751           0.683            0.621           3.791 (Except year 0) Present Value      -2,70,000.00      57,454.55 52,231.40 47,483.10 43,166.45 72,151.06     2,486.55 Annual Equivalent cost = Net Present Value / Present Value of ordinary annuity of 1 =        2,486.55 / 4 =            655.95 Working: Sale Price of Machine                 50,000 Book Value of Machine 0 Profit on sale                 50,000 Tax on profit                 17,000 After Tax sale of Machine                 33,000 Depreciation Expense under Straight Line = $ 2,50,000 / 5 = $     50,000 Machine B: Year 0 1 2 3 4 5 6 7 8 9 10 Total Cost of Machine (1) $        -3,20,000 Net Working Capital (2) -40,000 Saving in costs            70,000         70,000        70,000        70,000         70,000        70,000        70,000                  70,000        70,000         70,000 Depreciation Expense          -32,000       -32,000       -32,000       -32,000        -32,000       -32,000       -32,000                -32,000       -32,000       -32,000 Profit Before tax            38,000         38,000        38,000        38,000         38,000        38,000        38,000                  38,000        38,000         38,000 Tax Expense          -12,920       -12,920       -12,920       -12,920        -12,920       -12,920       -12,920                -12,920       -12,920       -12,920 Net Income            25,080         25,080        25,080        25,080         25,080        25,080        25,080                  25,080        25,080         25,080 Depreciation Expense            32,000         32,000        32,000        32,000         32,000        32,000        32,000                  32,000        32,000         32,000 Operating Cash flow (3)            57,080         57,080        57,080        57,080         57,080        57,080        57,080                  57,080        57,080         57,080 After tax sale price of Machine (4)         39,600 Release of Working capital (5)         40,000 Annual Cash flow (1) + (2) + (3) +(4) +(5) $        -3,60,000 $        57,080 $     57,080 $    57,080 $    57,080 $     57,080 $    57,080 $    57,080 $              57,080 $    57,080 $ 1,36,680 Discount factor 1.000              0.909           0.826           0.751           0.683            0.621           0.564           0.513                    0.467           0.424           0.386                 6.145 (Except Year 0) Present Value      -3,60,000.00      51,890.91 47,173.55 42,885.05 38,986.41 35,442.19 32,220.17 29,291.07            26,628.24 24,207.49 52,696.06      21,421.136 Annual Equivalent cost = Net Present Value / Present Value of ordinary annuity of 1 =      21,421.14 /                   6 =        3,486.19 Working: Sale Price of Machine                 60,000 Book Value of Machine 0 Profit on sale                 60,000 Tax on profit                 20,400 After Tax sale of Machine                 39,600 Depreciation Expense under Straight Line = $ 3,20,000 / 10 = $     32,000 Now, Machine A Machine B Annual Equiavlent Cost $ 655.95 $ 3,486.19 Annual Equiavlent Cost is positive.It means it is annual equivalent annual cash inflows. Due to higher Annual Equivalent Cost of Machine B, It is better to Choose Machine B.

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