Vandelay Industries is considering the purchase of a new machine for the product
ID: 2738416 • Letter: V
Question
Vandelay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,126,000 and will last for six years. Variable costs are 30 percent of sales, and fixed costs are $265,000 per year. Machine B costs $5,346,000 and will last for nine years. Variable costs for this machine are 25 percent of sales and fixed costs are $200,000 per year. The sales for each machine will be $11.5 million per year. The required return is 9 percent, and the tax rate is 34 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. Calculate the EAC for each machine. (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. 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.)
Explanation / Answer
Answer: 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. Using the bottom – up approach, or net income plus depreciation, method to calculate the OCF, we get:
The NPV and EAC for machine A is:
NPVA = -$3,126,000 - $2,274,760(PVIFA9%,6)
NPVA = -$13,330,345.88
EACA = -$13,330,345.88 / (PVIFA9%,6)
EACA = -$2,971, 610.13
And The NPV and EAC for machine B is:
NPVB = - $5,346,000 - $-1827540(PVIFA9%,9)
NPVB = -$16,302,467.81
EACB = -$16,302,467.81 / (PVIFA9%,6)
EACB= -$2,719,253.37
You should choose machine B since it has a less negative EAC.
Particulars Machine A Machine B Variable costs -3450000 -2875000 Fixed costs -265000 -200000 Depreciation -521000 -594000 EBT -4236000 -3669000 Tax -1440240 -1247460 Net income -2795760 -2421540 Depreciation 521000 594000 OCF -2274760 -1827540Related Questions
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