Vandalay Industries is considering the purchase of a new mac

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,048,000 and will last for six years. Variable costs are 40 percent of sales, and fixed costs are $195,000 per year. Machine B costs $5,229,000 and will last for nine years. Variable costs for this machine are 35 percent of sales and fixed costs are $130,000 per year. The sales for each machine will be $10.1 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.

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))

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,048,000 and will last for six years. Variable costs are 40 percent of sales, and fixed costs are $195,000 per year. Machine B costs $5,229,000 and will last for nine years. Variable costs for this machine are 35 percent of sales and fixed costs are $130,000 per year. The sales for each machine will be $10.1 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.

Solution

              Machine A               Machine B a Purchase Cost ($)                 3,048,000                 5,229,000 b Life of machines (years)                                  6                                  9 c Variable Cost ($)                 4,040,000                 3,535,000 d Fixed cost ($)                     195,000                     130,000 e Running cost per year (c+d)                 4,235,000                 3,665,000 f PVAF (based on life and 11% discount factor)                         4.231                         5.537 g Present Value of Running cost of machine (e*f)               17,918,285               20,293,105 h Cash outflow of machines (a+g)               20,966,285               25,522,105 i Equivalent Annual Cost (h/f)           4,955,397.07           4,609,374.21 We should choos machine B, since it has lower EAC