Vandalay Industries is considering the purchase of a new machine for the product

Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,960,000 and will last for 7 years. Variable costs are 37 percent of sales, and fixed costs are $147,000 per year. Machine B costs $4,550,000 and will last for 10 years. Variable costs for this machine are 30 percent of sales and fixed costs are $97,000 per year. The sales for each machine will be $9.1 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.

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

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

Explanation / Answer

(a)

operating cash flow = 1,960,000/7*35% + 9,100,000*(1-35%) - 9,100,000*37%*(1-35%) - 147,000*(1-35%) = 3,728,900

NPV = -1,960,000 + 3,728,900*PVIFA10%,7

EAC = NPV / PVIFA10%,7 = (-1,960,000 + 3,728,900*PVIFA10%,7)/PVIFA10%,7 = 3,326,305.22

(b)

operating cash flow = 4,550,000/10*35% + 9,100,000*(1-35%) - 9,100,000*30%*(1-35%) - 97,000*(1-35%) = 4,236,700

NPV = -4,550,000 + 4,236,700*PVIFA10%,10

EAC = NPV / PVIFA10%,10 = (-4,550,000 + 4,236,700*PVIFA10%,10)/PVIFA10%,10 = 3,496208.45

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