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# Comparing machines with unequal lives

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Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs \$2,310,000 and will last for 4 years. Variable costs are 37 percent of sales and fixed costs are \$157,000 per year. Machine B costs \$4,520,000 and will last for 8 years. Variable costs for this machine are 32 percent of sales and fixed costs are \$130,000 per year. The sales for each machine will be \$9,040,000 per year. The required return is 10 percent and the tax rate is 35 percent. Both machines will be depreciated on a straight-line basis.

If the company plans to replace the machine when it wears out on a perpetual basis, the EAC for machine A is \$ and the EAC for machine B is \$ . Therefore, you should choose machine B or A. (Negative amount should be indicated by a minus sign. Round answer to the nearest whole dollar amount, e.g. 32.)

#### Solution Preview

Machine A

Tax rate = 35%

Cost= \$2,310,000
Salvage value= \$0
Life= 4 years
Therefore, Annual depreciation= \$577,500 =\$2,310,000./4

Tax shield provided by depreciation=Tax rate x Annual depreciation= \$202,125 =35.%x\$577,500.

Revenue= \$9,040,000
Less Variable costs @ 37% = \$3,344,800 =37.%x\$9,040,000.
Contribution= \$5,695,200 =\$9,040,000. - \$3,344,800.
Less Fixed Costs \$157,000
Earnings before taxes= \$5,538,200 =\$5,695,200. - \$157,000.
Tax @ 35% = \$1,938,370 =35.%x\$5,538,200.
Profit after ...

\$2.19