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 $ 243,175 . 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:
Year1 : $ 390,000
Year 2 : $399,700
Year 3 : $410,200
Year 4 : $425,200
Year 5 : $433,400
Year 6 : $434,500
Year 7 : $437,400
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 $ 379,200 . This new equipment would require maintenance costs of $ 95,900 at the end of the fifth year. The cost of capital is 9%.
Calculate the net present value.
Determine whether Hillsong should purchase the new machine to replace the existing machine?
Net Present Value
NPV is a capital budgeting technique used to evaluate projects. NPV is difference between present value of cash flow and initial outlay.If NPV is positive than machine should be purchased.
Answer and Explanation:
Find Initial outlay
=Purchase of new machine+Training cost-salvage of old machine
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fromChapter 3 / Lesson 18
How does a business figure out the true cost and best means of obtaining capital? In this lesson, we will explore the cost of capital, flotation cost, net present value, and internal equity to help answer that question.