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 $260,000. 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 $350,000. 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 Hiland should purchase the new machine to replace the existing machine, and state the reason for your conclusion.