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 $ 241,835. 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		$ 389,500
	2		399,400
	3		411,000
	4		425,400
	5		433,700
	6		435,300
	7		437,300

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 $ 379,500. This new equipment would require maintenance costs of $ 94,500 at the end of the fifth year. The cost of capital is 9%.

HOW DO I SOLVE FOR NPV?

Answer 1

Initial investment of new equipment :

Investment in new equipment	$2450000
Disposal of old equipment	($241835)
Additional training required	$85000
Net initial investment required	$2293165

Year	discount	cash flow	present value
1	0.91743	$389500	$357339.45
2	0.84168	$399400	$336166.99
3	0.77218	$411000	$317367.41
4	0.70843	$425400	$301364.08
5	0.64993	$433700	$281875.24
6	0.59627	$435300	$259555.17
7	0.54703	$437300	$239218.08

Total present value = $2092886.42

Less: Maintainence at the end of year 5 = 0.64993 × $94500 = ($61418)

Add: terminal salvage at the end of year 7 = 0.54703 × $379500 = $207597.89

Present value of cash inflows = $2239066.31

Less: initial investment. = ($2293165)

Net present value = ($54098.69)

Based on the net present value the new machine should not be purchased.

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