Question

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 $242,003. 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 $389.700 400,800 3 410,800 425.700 6 433,000 434,600 437,000 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 $380,100. This new equipment would require maintenance costs of $95,700 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.s. -45 or parentheses e.g. (45). Round present value answer to O decimal places, eg. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Calculate the net present value. Net present values -53871 Determine whether Hillsong should purchase the new machine to replace the existing machine? No -

Answer 1

Net present value technique is popularly used capital budgeting to make purchase decisions of machineries. NPV equates to difference between cash inflows at present value and cash outflows at present value. If NPV is positive, the favorable decision can be made.

The net investment in the new sewing machine is given by:

= Cost of the new machine - selling price for the existing sewing machine + one-time training cost

= $2.45 million - $242,003 + $85,000

= $2,292,997

Year	Factor 9%	Amount	P.V
0    (Total cash outflows-A)	1.00000	(2,292,997)	(2,292,997)
1	0.91743	389,700	357522
2	0.84168	400,800	337345
3	0.77218	410,800	317212
4	0.70843	425,700	301579
5	0.64993	433,000	281420
6	0.59627	434,600	259139
7	0.54703	437,000	239052
Maintenance- year 5	0.64993	95,700	(62198)
Terminal Salvage	0.54703	380,100	207926
Total cash inflows (B)			$ 2,238,997
Net present value (A-B)			$(54,000)

Since, the net present value is negative , the machine should not be purchased.

Note that maintenance expense is deducted from inflows.

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