Question

Exercise 12-3

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 $ 240,438 . 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		$ 390,900
	2		399,800
	3		410,100
	4		425,400
	5		434,000
	6		434,900
	7		436,400

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 $ 379,100 . This new equipment would require maintenance costs of $ 94,000 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?

Yes                         No

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	-$240,438	1	-$240,438
Maintenance cost	5	$94,000	0.64993	$61,093
Present value of cash outflows (A)				$2,355,655
Cash Inflows:
Annual cost savings:
Year 1	1	$390,900	0.91743	$358,623
Year 2	2	$399,800	0.84168	$336,504
Year 3	3	$410,100	0.77218	$316,671
Year 4	4	$425,400	0.70843	$301,366
Year 5	5	$434,000	0.64993	$282,070
Year 6	6	$434,900	0.59627	$259,318
Year 7	7	$436,400	0.54703	$238,724
Salvage value of new machine	7	$379,100	0.54703	$207,379
Present value of cash Inflows (B)				$2,300,655
NPV (B-A)				-$55,001
As NPV is negative, hillsong should not purchase the new machine to replace existing machine.