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 $243,956. 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		$391,000
	2		399,900
	3		410,300
	4		425,600
	5		432,100
	6		435,200
	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 $379,400. This new equipment would require maintenance costs of $98,600 at the end of the fifth year. The cost of capital is 9%.

Use the net present value method to determine the following:

Calculate the net present value.

Determine whether Hillsong should purchase the new machine to replace the existing machine?

Answer 1

Solution

Hillsong Inc

Calculation of the net present value:

Investment in new equipment = $2,450,000

Disposal of old equipment = ($243,956)

Additional training cost = $85,000

Net initial investment needed = $2,291,044

Yr	Discount factor 9%	amount	present value
1	0.91743	$391,000	$358,715
2	0.84168	$399,900	$336,588
3	0.77218	$410,300	$316,825
4	0.70843	$425,600	$301,508
5	0.64993	$432,100	$280,835
6	0.59627	$435,200	$259,497
7	0.54703	$437,300	$239,216
Total			$2,093,184
maintenance in 5th year	0.64993	($98,600)	($64,083)
terminal value at 7th year	0.54703	$379,400	$207,543
present value of cash inflows	$2,236,644
less: present value of initial investment	($2,291,044)
net present value		($54,400)

No, Hillsong should not purchase the new machine to replace the existing machine.

Since, the net present value is negative, the investment is not profitable to Hillsong.