Sheep Counting Gone, Inc. is considering the purchase of a new machine for the p

Question

Sheep Counting Gone, Inc. is considering the purchase of a new machine for the production of next-generation memory foam. Machine A costs $3,120,000 and will last for six years. Variable costs are 40 percent of sales, and fixed costs are $260,000 per year. Machine B costs $5,337,000 and will last for nine years. Variable costs for this machine are 35 percent of sales and fixed costs are $195,000 per year. The sales for each machine will be $11.4 million per year. The required return is 11 percent, and the tax rate is 30 percent. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Note: Since we need to calculate the EAC for each machine, sales are irrelevant. EAC only uses the costs of operating the equipment, not the sales.

Calculate the NPV for each machine. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

Calculate the EAC for each machine. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places. (e.g., 32.16))

Sheep Counting Gone, Inc. is considering the purchase of a new machine for the production of next-generation memory foam. Machine A costs $3,120,000 and will last for six years. Variable costs are 40 percent of sales, and fixed costs are $260,000 per year. Machine B costs $5,337,000 and will last for nine years. Variable costs for this machine are 35 percent of sales and fixed costs are $195,000 per year. The sales for each machine will be $11.4 million per year. The required return is 11 percent, and the tax rate is 30 percent. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Note: Since we need to calculate the EAC for each machine, sales are irrelevant. EAC only uses the costs of operating the equipment, not the sales.

Explanation / Answer

(a) (i) Computation of the NPV of the machine A and machine B.We have,

(b) Computation of the EAC of machine A and machine B.We have,

EAC = Asset price x discount rate / [1 - 1/ (1+discount rate)number of periods]

For Machine A:

EAC = 3,120,000 x 11% / [ 1 - 1/(1.11)6 ]

EAC = 343,200 / [ 1 - 0.535] = 343,200 / 0.465 = $ 738,064.52

For Machine B:

EAC = 5,337,000 x 11% / [ 1 - 1/(1.11)9]

EAC = 587,070 / [1 - 0.391 ]

EAC = $ 963,990.15

Since, the NPV and EAC of the Machine B is higher than Machine A.Therefore, Machine B should be choose.

s

Particulars Machine A Machine B Sales 11,400,000 11,400,000 Less: Variable cost 4,560,000 3,990,000 Contribution 6,840,000 7,410,000 Less:Fixed Cost 260,000 195,000 Less: Depreciation 520,000 593,000 EAT 6,060,000 6,622,000 Less: tax expense 2,424,000 2,648,800 Earning after tax 3,636,000 3,973,200 Add: Depreciation 520,000 593,000 Cash Inflow 4,156,000 4,566,200 PVIFA(11%) 4.230 5.537 Present value of cash inflow 17,579,880 25,283,049 Less: Cash Outflow 3,120,000 5,337,000 NPV $ 14,459,880 $ 19,946,049

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