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 $3,078,000 and will last for six years. Variable costs are 30 percent of sales, and fixed costs are $220,000 per year. Machine B costs $5,274,000 and will last for nine years. Variable costs for this machine are 25 percent of sales and fixed costs are $155,000 per year. The sales for each machine will be $10.6 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.

Explanation / Answer

Answer:

The NPV and EAC for Machine A are:

NPV A = –$3078,000 – $2,069580 (PVIFA 9%,6 )

NPV A = –$12361929

EAC A = –$1 2361929/ (PVIFA 9%,6 )

EAC A = -$2755730

And the NPV and EAC for Machine B are:

NPV B = –$5,274,000 – $-1652060(PVIFA 9%,9 )

NPV B = –$15178430.112

EAC B = –$15178430.112/ (PVIFA 9%,9 )

EAC B = –$2531763.76

You should choose Machine B since it has a more positive EAC.

Particulars Machine A Machine B Variable cost -3180000 -2650000 Fixed costs -220000 -155000 Depreciation -513000 -586000 EBT -3913000 -3391000 Tax 1330420 1152940 Net income -2582580 -2238060 Add: Dep 513000 586000 OCF -2069580 -1652060

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