Exercise 24-3 Hiland Inc. manufactures snowsuits. Hiland is considering purchasi

Question

Exercise 24-3

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 $242,342. 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:

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 $380,400. This new equipment would require maintenance costs of $96,200 at the end of the fifth year. The cost of capital is 9%.

Click here to view the factor table.

(For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

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 answer for present value to 0 decimal places, e.g. 125.)

Calculate the net present value.

Should Hiland Inc. purchase the new machine to replace the existing machine?

Year 1 $389,100 2 399,500 3 410,700 4 425,300 5 433,100 6 434,900 7 436,400

Explanation / Answer

Details   Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 New m/c cost             2,450,000 Depreciation details @20%DDB            490,000          392,000          313,600              250,880          200,704           160,563          128,451 Book Value at the end of Year 7                 513,802 Salvage value                   380,400 Tax rate not given , so ignored Investment in new machine           (2,450,000) Less resale value old m/c                 242,342 Training cost                 (85,000) Operational cost saving            389,100          399,500          410,700              425,300          433,100           434,900          436,400 Maintenance cost          (96,200) Salvage value            380,400 Net Cash flow           (2,292,658)            389,100          399,500          410,700              425,300          336,900           434,900          816,800 PV factor @9%                              1                 0.917               0.842               0.772                   0.708              0.650               0.596               0.547 PV of Cash flows           (2,292,658)            356,972          336,251          317,136              301,293          218,962           259,317          446,818 NPV =                 (55,909) As the NPV is negative, the investment should not be done

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