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 $250,000. 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 $390,000
2 400,000
3 411,000
4 426,000
5 434,000
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 $400,000. This new equipment would require maintenance costs of $100,000 at the end of the fifth year. The cost of capital is 9%.
Instructions
Use the net present value method to determine whether Hillsong should purchase the new machine to replace the existing machine, and state the reason for your conclus

Answer 1

Answer:

NPV = 37,599 Negative

Explanation:

We can calculate the NPV of the new sewing machine by deducting the Present value of future cash inflows by Investment

Initial investment = Machine cost + Training cost - Salvage value

Initial investment = 2,450,000 + 85,000 - 250,000

Initial investment = 2,285,000

Year                                      DF(9%)   Present Value

1  Cash inflow     390,000  x 0.917      $357,798

2 Cash inflow     400,000  x 0.842    $336,672

3 Cash inflow     411,000   x  0.772     $317,367

4 Cash inflow     426,000  x 0.708     $301,789

5 Cash inflow     334,100  x 0.650     $217,077       (434,100 - 100,000)

6 Cash inflow     435,000  x 0.596    $259,376

7 Cash inflow     436,000 x 0.547     $238,507

7 Salvage value 400,000 x 0.547     $218,814  

     

Present Value of cash inflow             $2,247,401

Initial investment                                $2,285,000

NPV ($2,247,401 - $2,285,000)          (37,599)    

Conclusion: Hillsong should not purchase the new machine as the NPV of the machine is negative