Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $2.71 million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $45,000 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 $10.1 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 $4.98 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 69% of their sale price. The increased production will also require increased inventory on hand of $1.09 million during the life of the project. The increased production will require additional inventory of $1.09 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 $2.06 million per year.

Accounting: The XC-750 will be depreciated via the straight-line method in years 1-10. Receivables are expected to be14% of revenues and payables to be 9% 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 9.6%, compute the NPV of the purchase.

d. While the expected new sales will be $10.1 million per year from the expansion, estimates range from $8.05 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 as a percentage of sales?

f. Billingham could instead purchase the XC-900, which offers even greater capacity. The cost of the XC-900 is $3.97 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 $10.1 million expected for the XC-750) per year in those years would justify purchasing the larger machine?