Reference no: EM132459338

Problem:

Billingham Packaging is considering expanding its production capacity by purchasing a new? machine, the? XC-750. The cost of the? XC-750 is $2.68 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 operating next?year, the extra capacity is expected to generate $ 10.05 million per year in additional?sales, which will continue for the?ten-year life of the machine.
• ?Operations: The disruption caused by the installation will decrease sales by $4.93 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 71% of their sale price. The increased production will also require increased inventory on hand of $1.07 million during the life of the project. The increased production will require additional inventory of $1.07 ?million, to be added in year 0 and depleted in year 10.
• Human?Resources: The expansion will require additional sales and administrative personnel at a cost of $2 million per year.
• ?Accounting: The?XC-750 will be depreciated via the?straight-line method in years?1 and 10. Receivables are expected to be 15% of revenues and payables to be 11% of the cost of goods sold.?Billingham's marginal corporate tax rate is 15%.

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 10.3 %?, compute the NPV of the purchase.

d) While the expected new sales will be $ 10.05 million per year from the? expansion, estimates range from $ 7.95 million to $ 12.15 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? break-even 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 $ 3.98 million. The extra capacity would not be useful in the first two years of? operation, but would allow for additional sales in years? 3-10. What level of additional sales? (above the $ 10.05 million expected for the? XC-750) per year in those years would justify purchasing the larger? machine?