Question

Vandelay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,170,000 and will last for six years. Variable costs are 39 percent of sales, and fixed costs are $310,000 per year. Machine B costs $5,403,000 and will last for nine years. Variable costs for this machine are 34 percent of sales and fixed costs are $220,000 per year. The sales for each machine will be $12 million per year. The required return is 12 percent, and the tax rate is 25 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. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) Which machine should the company choose?

Answer 1

Solution :

The EAC of Machine A = - $ 4,381,442.19

The EAC of Machine B = - $ 4,088,945.70

The company should choose Machine B with a lower EAC of - $ 4,088,945.70

Please find the attached screenshots of the excel sheet containing the detailed calculation for the solution.

06.11.2019 Microsoft Excel Sig НOМE FORMULAS FILE INSERT PAGE LAYOUT DATA REVIEW VIEW A B C. D Е F G н к M N O Statement showing calculation of EAC Machine A 1 Depreciation Total cost 3170000/ 6before tax 528,333.33 (4) SI.No. Year Particulars Variable costs Fixed cost Total cost after Addback tax shield (7) (5)- (6) Discounted Cash Tax@ 25% Annual sales Total cash PV Depreciation outflows (8) (7)(4) (9) 1 Cash outflow Year 1 $12,000,000.00 $-4,680,000.00 $-310,000.00 $-528,333.33 $-5,518,333.33 $-1,379,583.33 $-4,138,750.00 $528,333.33 $-3,610,416.67 2 Cash outflow Year 2 $12,000,000.00 $-4,680,000.00 $-310,000.00 $-528,333.33 $-5,518,333.33 $-1,379,583.33 $-4,138,750.00 $528,333.33 $-3,610,416.67 3 Cash outflow Year 3 $12,000,000.00 $-4,680,000.00 $-310,000.00 $-528,333.33 $-5,518,333.33 $-1,379,583.33 $-4,138,750.00 $528,333.33 $-3,610,416.67 4 Cash outflow Year 4 $12,000,000.00 $-4,680,000.00 $-310,000.00 $-528,333.33 $-5,518,333.33 $-1,379,583.33 $-4,138,750.00 $528,333.33 $-3,610,416.67 5 Cash outflow Year 5 $12,000,000.00 $-4,680,000.00 $-310,000.00 $-528,333.33 $-5,518,333.33 $-1,379,583.33 $-4,138, 750.00 $528,333.33 $-3,610,416.67 6 Cash outflow Year 6 $12,000,000.00 $-4,680,000.00 $-310,000o.00 $-528,333.33 $-5,518,333.33 $-1,379,583.33 $-4,138,750.00 $528,333.33 $-3,610,416.67 (1) (3) (6) (5) 0.25 Factor @ outflows - (1) 0.39 - Sales 0.39 (10) (8) (9) shield (4) 12 % |(5)=(2)+(3)+(4) (2) 2 0.8929 -3,223,586.31 1 0.7972 $ -2,878, 202.06 2 0.7118 $ -2,569,823.27 0.6355 -2, 294,485.06 0.5674 -2,048,647.38 5 6 7 5 0.5066 -1,829, 149.44 8 6 $-14,843,893.52 1.0000 $ -3,170,000.00 Total of discounted cash outflows 9 7 Initial Investment $-3,170,000.00 10 8 0 Net Total cash Outflows (7) (8) $-18,013,893.52 11 9 PVIFA at 12% for 6 years 12 10 4.1114 EAC (9)/ (10) = Total of cash outflows / PVIFA at 12 % for 6 years $ -4,381,442.19 13 11 14 15 16 17 18

06.11.2019 Microsoft Excel Sig FILE HOME INSERT PAGE LAYOUT FORMULAS DATA REVIEW VIEW L AB C D F G H K M N O 28 Statement showing calculation of EAC Machine B 29 Discounted Cash Variable costs Fixed cost Depreciation Total cost -5403000/ 9 = before tax Tax@ 25 % SI.No. Year Particulars Total cash Depreciatin outflows (8) (7)+(4) (9) 1 Cash outflow Year 1 $12,000,000.00 $-4,080,000.00 $-220,000o.00 $-600,333.33 $-4,900,333.33 $-1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 2 Cash outflow Year 2 $12,000,000.00 $-4,080,000.00 $-220,000.00 $-600,333.33 $-4,900,333.33 $-1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 3 Cash outflow Year 3 $12,000,000.00 $-4,080,000.00 $-220,000o.00 $-600,333.33 $-4,900,333.33 -1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 4 Cash outflow Year 4 $12,000,000.00 $-4,080,000.00 $-220,000o.00 $-600,333.33 $-4,900,333.33 -1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 5 Cash outflow Year 5 $12,000,000.00 $-4,080,000.00 $-220,000o.00 $-600,333.33 $-4,900,333.33 $-1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 6 Cash outflow Year 6 $12,000,000.00 $-4,080,000.00 $-220,000o.00 $-600,333.33 $-4,900,333.33 $-1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 7 Cash outflow Year 7 $12,000,000.00 $-4,080,000.00 $-220,000.00 $-600,333.33 $-4,900,333.33 $-1, 225, 083.33 $-3,675, 250.00 $600,333.33 -3,074,916.67 8 Cash outflow Year 8 $12,000,000.00 $-4,080,000.00 $-220,000o.00 $-600,333.33 $-4,900,333.33 -1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 9 Cash outflow Year 9 $12,000,000.00 $-4,080,000.00 $-220,000o.00 $-600,333.33 $-4,900,333.33 -1,225,083.33 $-3,675,250.00 $600,333.33 $-3,074,916.67 Annual sales Total cost after Addback: PV - 1)*0.34 (1) (3) Factor @ outflows (6) (5)* 0.25 tax shield (10) (8) (9) (4) shield (7) (5)- (6) 12 % -Sales 0.34 600,333.33 (4) (2) (5)=(2)+(3)+(4) 30 0.8929 -2,745,461.31 0.7972 $ -2,451,304.74 0.7118 $2,188,664.95 31 1 32 2 33 3 0.6355 $-1,954,165.13 0.5674 -1,744,790.30 34 4 35 5 0.5066 $ -1,557,848.48 36 6 0.4523 -1,390,936.14 37 7 0.4039 -1,241,907.27 38 8 0.3606 -1,108,845.78 39 9 $-16,383,924.09 1.0000 -5,403,000.00 Total of discounted cash outflows 40 10 $-5,403,000.00 Initial Investment 41 11 Net Total cash Outflows (10) + (11) $-21,786,924.09 12 42 PVIFA at 12% for 9 years 43 13 5.3282 EAC (12)/ (13) = Total of cash outflows / PVIFA at 12 % for 9 years $-4,088,945.70 44 14 45 46 47