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Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC - 7 5 0 . The cost of the XC

Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is
$2.76.82
million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a
$54 comma 00054,000
feasibility study to analyze the decision to buy the XC-750, resulting in the following estimates:
bullet
Marketing: Once the XC-750 is operating next year, the extra capacity is expected to generate
$10.1510.15
million per year in additional sales, which will continue for the10-year life of the machine.
bullet
Operations: The disruption caused by the installation will decrease sales by
$4.964.96
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
70%70%
of their sale price. The increased production will require additional inventory on hand of
$1.801.80
million to be added in year 0 and depleted in year 10.
bullet
Human Resources: The expansion will require additional sales and administrative personnel at a cost of
$2.132.13
million per year.
bullet
Accounting: The XC-750 will be depreciated via the straight-line method over the10-year life of the machine. Receivables are expected to be
16%16%
of revenues and payables to be
12%12%
of the cost of goods sold. Billingham's marginal corporate tax rate is
15%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%10.3%,
compute the NPV of the purchase.
d. While the expected new sales will be
$10.1510.15
million per year from the expansion, estimates range from
$8.158.15
million to
$ 12.15$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
$4.204.20
million. The extra capacity would not be useful in the first two years of operation, but would allow for additional sales in years
3dash10.
What level of additional sales(above the
$10.1510.15
million expected for the XC-750) per year in those years would justify purchasing the larger machine?

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