Hiland Inc. manufactures snowsuits. Hiland is considering purchasing a new sewin
ID: 2468864 • Letter: H
Question
Hiland Inc. manufactures snowsuits. Hiland 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, Hiland spent $55,000 to keep it operational. The existing sewing machine can be sold today for $241,046. 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) $390,400 Year 2) 399,800 Year 3) 410,900 Year 4) 425,100 Year 5) 434,000 Year 6) 434,600 Year 7) 436,500 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 $379,600. This new equipment would require maintenance costs of $96,000 at the end of the fifth year. The cost of capital is 9%. Calculate Net Present Value. Determine if the company should purchace a new machine to replace the existing machine.
Explanation / Answer
Computing the initial investment outlay of a replacement project is slightly different. This is primarily because of the expected cash flow a company may receive on the sale of the equipment to be replaced.
Value of the old machine = Sale Value + tax benefit/loss
= $241,046
(Being no Tax rate is mentioned in the query, we consider nil tax benefits)
We shall not consider the historical value of old machine as well the $55,000 overhaul charges spent, being historical cost shall not affect the future decisions.
Net Present Value Calculation:
Year
Operating Cost Reduction (inflow)
Salvage Value (inflow)
Purchases Cost (Outlow)
Training Cost (Outflow)
Maintenance Cost (Outflow)
Net cash Flows (B+C-D-E-F)
Discounting Factor @
Net Present Value of Cash Flows (GXH)
A
B
C
D
E
F
G
H
I
0
$241,046.00
$2,450,000.00
$85,000.00
$-2,293,954.00
1.00000
$ -2,293,954.00
1
$390,400.00
$390,400.00
0.91743
$ 358,165.14
2
$399,800.00
$399,800.00
0.84168
$ 336,503.66
3
$410,900.00
$410,900.00
0.77218
$ 317,290.19
4
$425,100.00
$425,100.00
0.70843
$ 301,151.56
5
$434,000.00
$96,000.00
$338,000.00
0.64993
$ 219,676.81
6
$434,600.00
$434,600.00
0.59627
$ 259,137.78
7
$436,500.00
$379,600.00
$816,100.00
0.54703
$ 446,434.65
1. Net Present Value
$ -55,594.22
Note: Being the Tax Rate is not provided, we have not able to consider the depreciation and loss on sale benefits in the query.
2. NO, Being the NPA is negative the Hiland Inc. should not purchase the new machine for replacing the old machine.
Year
Operating Cost Reduction (inflow)
Salvage Value (inflow)
Purchases Cost (Outlow)
Training Cost (Outflow)
Maintenance Cost (Outflow)
Net cash Flows (B+C-D-E-F)
Discounting Factor @
Net Present Value of Cash Flows (GXH)
A
B
C
D
E
F
G
H
I
0
$241,046.00
$2,450,000.00
$85,000.00
$-2,293,954.00
1.00000
$ -2,293,954.00
1
$390,400.00
$390,400.00
0.91743
$ 358,165.14
2
$399,800.00
$399,800.00
0.84168
$ 336,503.66
3
$410,900.00
$410,900.00
0.77218
$ 317,290.19
4
$425,100.00
$425,100.00
0.70843
$ 301,151.56
5
$434,000.00
$96,000.00
$338,000.00
0.64993
$ 219,676.81
6
$434,600.00
$434,600.00
0.59627
$ 259,137.78
7
$436,500.00
$379,600.00
$816,100.00
0.54703
$ 446,434.65
1. Net Present Value
$ -55,594.22
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