Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the

XC-750. The cost of the XC-750 is $2.75 million. Unfortunately, installing this machine will take several months

and will partially disrupt production. The firm has just completed a $50,000 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 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 $5 million this year. As with

Billingham? existing products, the cost of goods for the products produced by the XC-750 is expected to be

70% of their sale price. The increased production will also require increased inventory on hand of $1 million

during the life of the project. The increased production will require additional inventory of $1 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?10. Receivables are

expected to be 15% of revenues and payables to be 10% of the cost of goods sold. Billingham? 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 10.0%, compute the NPV of the purchase.

d. While the expected new sales will be $10 million per year from the expansion, estimates range from

$8 million to $12 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

$4 million. The extra capacity would not be useful in the first two years of operation, but would allow for additional