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 $245,090. 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 $389,800 2 399,800 3 410,200 4 425,400 5 432,400 6 435,000 7 436,000 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 $380,800. This new equipment would require maintenance costs of $99,000 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	-$245,090	1	-$245,090
Maintenance cost	5	$99,000	0.64993	$64,343
Present value of cash outflows (A)				$2,354,253
Cash Inflows:
Annual cost savings:
Year 1	1	$389,800	0.91743	$357,614
Year 2	2	$399,800	0.84168	$336,504
Year 3	3	$410,200	0.77218	$316,748
Year 4	4	$425,400	0.70843	$301,366
Year 5	5	$432,400	0.64993	$281,030
Year 6	6	$435,000	0.59627	$259,377
Year 7	7	$436,000	0.54703	$238,505
Salvage value of new machine	7	$380,800	0.54703	$208,309
Present value of cash Inflows (B)				$2,299,454
NPV (B-A)				-$54,800

As NPV is negative, therefore new machine should not be replaced with existing machine.