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 $240,164. 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 $390,800 2 399,000 3 410,800 4 425,700 5 432,700 6 434,700 7 437,600 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 $379,900. This new equipment would require maintenance costs of $95,300 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 equipment - Hillsong Inc.
Particulars	Period	Amount	PV Factor	Present Value
Cash Outflows:
Cost of new equipment	0	$2,450,000.00	1	$2,450,000
Sale value of old equipment	0	-$240,164.00	1	-$240,164
Training cost	0	$85,000.00	1	$85,000
Maintenane Cost	5	$95,300.00	0.64993	$61,938
Present value of cash outflows (A)				$2,356,774
Cash Inflows:
Decrease in operating cost:
Year 1	1	$390,800.00	0.91743	$358,532
Year 2	2	$399,000.00	0.84168	$335,830
Year 3	3	$410,800.00	0.77218	$317,212
Year 4	4	$425,700.00	0.70843	$301,579
Year 5	5	$432,700.00	0.64993	$281,225
Year 6	6	$434,700.00	0.59627	$259,199
Year 7	7	$437,600.00	0.54703	$239,380
Salvage value of new machine	7	$379,900.00	0.54703	$207,817
Present value of cash Inflows (B)				$2,300,772
NPV (B-A)				-$56,002

AS NPV is negative, therefore Hillsong should not purchase the new machine to replace the existing machine.