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 $241,533. 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: $389,600 Year 1 2 399,600 410,800 3 4 426,000 5 433,300 6 434,600 7 436,700 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 $379,000. This new equipment would require maintenance costs of $95,500 at the end of the fifth year. The cost of capital is 9%. Click here to view PV table. 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

Solution:

Computation of NPV - Replacement proposal of Sewing Machine - Hillsong Inc.
Particulars	Period	Amount	PV Factor (9%)	Present Value
Cash Outflows:
Cost of new sewing machine	0	$2,450,000	1	$2,450,000
Training cost	0	$85,000	1	$85,000
Sale value of current machine	0	-$241,533	1	-$241,533
Maintenance cost	5	$95,500	0.64993	$62,068
Present value of cash outflows (A)				$2,355,535
Cash Inflows:
Annual cost savings:
Year 1	1	$389,600	0.91743	$357,431
Year 2	2	$399,600	0.84168	$336,335
Year 3	3	$410,800	0.77218	$317,212
Year 4	4	$426,000	0.70843	$301,791
Year 5	5	$433,300	0.64993	$281,615
Year 6	6	$434,600	0.59627	$259,139
Year 7	7	$436,700	0.54703	$238,888
Salvage value of new machine	7	$379,000	0.54703	$207,324
Present value of cash Inflows (B)				$2,299,735
NPV (B-A)				-$55,801

As NPV is negative, therefore Hillsong should not purchase the new machine.