Reference no: EM13498262

Question III Hill Inc.

Hill Inc. makes "math manipulatives" that are used to assist students learn math. The manipulatives are made using an extrusion machine that was purchased five years ago. Hill makes and sells 1,000,000 manipulatives using the machine each year. The cost of resin used to make the manipulatives is $125,000 per year. The current machine was acquired for $100,000, has a book value of $50,000 (as of December 31, 2011) and an estimated remaining life (as of December 31, 2011) of five years with no salvage value.

In December, 2011, James Hill, CEO of Hill Inc., received an announcement that an updated extrusion machine that uses less resin to make a manipulative was developed and would be available on January 1, 2012. The new machine costs $120,000, has a five-year life and no salvage value. Hill also would receive $20,000 for trading in the current machine. The new machine would make 1,000,000 manipulatives each year using resin that would cost $75,000 per year; other manufacturing costs (e.g., labor, variable overhead) would be unchanged.

James asked you to determine whether to purchase the new machine and trade in the current machine.

Assume that the selling price for manipulatives is $1 each, other manufacturing costs excluding depreciation (e.g., labor, variable overhead paid in cash) total $340,000 per year, Hill's tax rate is 30%, and its cost of capital is 10% per year. For simplicity, also assume that all cash flows, except for the amount paid for a new extrusion machine, occur on December 31 of each year. (If the extrusion machine is purchased, payment is made on January 1, 2012.)

1. Calculate Hill's projected net income (after tax) for 2012 if it continues to use the current machine.

2. Calculate Hill's projected net income (after tax) for 2012 if it trades in the current machine and purchases the new machine on January 1, 2012.

3. Calculate the difference in cash flows on December 31, 2012 if Hill purchases the new machine. (Exclude the amount paid for the new extrusion equipment if it is purchased because that cash flow is assumed to occur on January 1, 2012.)

Answer: If Hill purchases the new machine, cash flow for 2012 is:

4. Calculate the difference in cash flows on December 31, 2013 if Hill purchases the new machine.

Answer: If Hill purchases the new machine, cash flow for 2013 is:

HIGHER or LOWER (choose one) by ______________ (amount.)

5. Hill's policy is to acquire new equipment when the present value of future cash flows is higher with new equipment than the present value of future cash flows with old equipment. Based on Hill's policy, do you recommend that Hill purchase the new machine?