Question

Exercise 12-3 (Video)

Hillsong Inc. manufactures snowsuits. Hillsong is considering purchasing a new sewing machine at a cost of $2.45 million. Its existing machine was purchased five years ago at a price of $1.8 million; six months ago, Hillsong spent $55,000 to keep it operational. The existing sewing machine can be sold today for $240,845. The new sewing machine would require a one-time, $85,000 training cost. Operating costs would decrease by the following amounts for years 1 to 7:

Year	1		$391,000
	2		399,100
	3		411,000
	4		426,000
	5		433,200
	6		435,300
	7		436,500

The new sewing machine would be depreciated according to the declining-balance method at a rate of 20%. The salvage value is expected to be $379,800. This new equipment would require maintenance costs of $94,900 at the end of the fifth year. The cost of capital is 9%.

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Use the net present value method to determine the following: (If net present value is negative then enter with negative sign preceding the number e.g. -45 or parentheses e.g. (45). Round present value answer to 0 decimal places, e.g. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Calculate the net present value.

Net present value

$

Determine whether Hillsong should purchase the new machine to replace the existing machine?

Answer 1

Investment in new equipment: $2,450,000

Disposal of old equipment: (240,845 )

Additional training required:85,000

Net initial investment required: $ 2294,155

Year	Discount factor	Cash flow	Present value of cash flows
1	391,000	0.91743	358,715
2	399,100	0.84168	335,914
3	411,000	0.77218	317,366
4	426,000	0.70843	301,791
5	433,200	0.64993	281,550
6	435,300	0.59627	259,556
7	436,500	0.54703	238,779
		Total	2093,671

Maintenance at end of year 5 = 0.64993 * 94900 = $ 61678

Terminal value = 0.54703 * 379,800 = 207,762

Total present value of inflows = 2093,671 -61,678 + 207,762 = $ 2239,755

Net present value = 2239,755 - 2294,155 = - $ 54,400

Net present value of the new Machine is negative Hence. Hillsong Inc should not purchase the new Machine.

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