Question
Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $ 2.76 million. Unfortunately,
Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $ 2.76 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: bullet Marketing: Once the XC-750 is operational next year, the extra capacity is expected to generate $ 10.00 million per year in additional sales, which will continue for the 10-year life of the machine. bullet Operations: The disruption caused by the installation will decrease sales by $ 5.01 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 68 % of their sale price. The increased production will also require increased inventory on hand of $ 1.11 million during the life of the project, including year 0. bullet Human Resources: The expansion will require additional sales and administrative personnel at a cost of $ 2.09 million per year. bullet 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 14 % of revenues and payables to be 10 % of the cost of goods sold. Billingham's marginal corporate tax rate is 35 %.
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 9.8%, compute the NPV of the purchase.
d. While the expected new sales will be $10.00 million per year from the expansion, estimates range from $7.95 million to $12.05 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 $10.00 million expected for the XC-750) per year in those years would justify purchasing the larger machine?
Incremental Effects | ||||
Year |
| 0 | ||
Sales Revenues | $ |
| ||
Cost of Goods Sold | $ |
| ||
S, G, and A Expenses | $ |
| ||
Depreciation | $ |
| ||
EBIT | $ |
| ||
Taxes at 35% | $ |
| ||
Unlevered Net Income | $ |
|
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started