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Comparing machines with unequal lives

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.)

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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 ...