E24-3 Hillsong Inc. manufactures snowsuits. Hillsong is considering purchasing a
ID: 2587153 • Letter: E
Question
E24-3 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 $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 $390,000 400,000 411,000 426,000 434,000 435,000 436,000 4 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 conclusion. (CGA adapted)Explanation / Answer
Investment in new equipment: $2,450,000
Disposal of old equipment: (250,000 )
Additional training required: 85,000
Net initial investment required: $2,285,000
Year Discount Cash Fows Dis.CF
1 0.91743 $390,000 $357,798
2 0.84168 400,000 336,672
3 0.77218 411,000 317,366
4 0.70843 426,000 301,791
5 0.64993 434,000 282,070
6 0.59627 435,000 259,377
7 0.54703 436,000 238,505
Maintenance @ end of yr 5 0.64993 (100,000) = (64,993)
Net cash Fows from operations: 2,028,586
Terminal Salvage 7 0.54703 350,000 191,460
Present value of cash inFows 2,220,047
Initial investment (2,285,000)
Net Present Value = (64,953)
Based on the net present value, the sewing machine should not be purchased
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