Question

Renegade Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3.11 million and will last for six years. Variable costs are 31% of sales, and fixed costs are $1,960,702 per year. Machine B costs $5.06 million and will last for nine years. Variable costs for this machine are 20% of sales and fixed costs are $1,443,569 per year. The sales for each machine will be $10 million per year. The required return is 7 %, and the tax rate is 38%. Both machines will be depreciated on a straightline basis. The company plans to replace the machine when it wears out on a perpetual basis. Calculate the EAC for machine A. (Round answer to 0 decimal places. Do not round intermediate calculations)

Answer 1

To calculate the EAC for machine A, we need to find the present value of the cash flows associated with the machine over its useful life. The annual cash flow is calculated as the sales minus variable costs minus fixed costs. The present value is then divided by the annuity factor to find the EAC.

Step-by-step explanation:

To calculate the EAC (Equivalent Annual Cost) for machine A, we need to find the present value of the cash flows associated with the machine over its useful life. First, we calculate the annual cash flow, which is the sales minus variable costs minus fixed costs. Then, we calculate the present value of the cash flows using the required return rate as the discount rate. Finally, we divide the present value by the annuity factor to find the EAC.

The annual cash flow for machine A is calculated as follows:

Sales: $10 million

Variable costs: 31% of sales = 0.31 x $10 million = $3.1 million

Fixed costs: $1,960,702

Annual cash flow: $10 million - $3.1 million - $1,960,702 = $5,939,298

The present value of the annual cash flows is calculated using the formula:

Present value = Annual cash flow / ((1 + required return rate) ^ useful life)

Present value = $5,939,298 / ((1 + 0.07) ^ 6) = $4,525,709.79

Finally, we divide the present value by the annuity factor:

EAC = Present value / annuity factor

Annuity factor = ((1 - (1 / ((1 + required return rate) ^ useful life))) / required return rate)

Annuity factor = ((1 - (1 / ((1 + 0.07) ^ 6))) / 0.07) = 4.818769436

EAC = $4,525,709.79 / 4.818769436 = $938,555.49