Reference no: EM132696182

Billingham Packaging is considering expanding its production capacity by purchasing a new? machine, the? XC-750. The cost of the? XC-750 is $2.83 million.? Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $46,000 feasibility study to analyze the decision to buy the? XC-750, resulting in the following? estimates:

• ?Marketing: Once the? XC-750 is operational next? year, the extra capacity is expected to generate $10.15 million per year in additional? sales, which will continue for the? 10-year life of the machine.

• ?Operations: The disruption caused by the installation will decrease sales by $5.07 million this year. As with? Billingham's existing? products, the cost of goods for the products produced by the? XC-750 is expected to be 72% of their sale price. The
increased production will also require increased inventory on hand of $1.16 million during the life of the? project, including year 0.

• Human? Resources: The expansion will require additional sales and administrative personnel at a cost of $1.99 million per year.

• ?Accounting: The? XC-750 will be depreciated via the? straight-line method over the? 10-year life of the machine. The firm expects receivables from the new sales to be 16% of revenues and payables to be 11% of the cost of goods sold.? Billingham's marginal corporate tax rate is 21%.

a. Determine the incremental earnings from the purchase of the? XC-750.

b. Determine the free cash flow from the purchase of the? XC-750.

c. If the appropriate cost of capital for the expansion is 9.9%?, compute the NPV of the purchase.

d. While the expected new sales will be $10.15 million per year from the? expansion, estimates range from $8.05 million to $12.25 million. What is the NPV in the worst? case? In the best? case?

e. What is the? break-even level of new sales from the? expansion? What is the breakeven level for the cost of goods? sold?

f. Billingham could instead purchase the? XC-900, which offers even greater capacity. The cost of the? XC-900 is $4.09 million. The extra capacity would not be useful in the first two years of? operation, but would allow for additional sales in years 3 through 10. What level of additional sales? (above the $10.15 million expected for the? XC-750) per year in those years would justify purchasing the larger? machine?