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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 The cost of the XC is
$
million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a
$ comma
feasibility study to analyze the decision to buy the XC resulting in the following estimates:
bullet
Marketing: Once the XC is operating next year, the extra capacity is expected to generate
$
million per year in additional sales, which will continue for theyear life of the machine.
bullet
Operations: The disruption caused by the installation will decrease sales by
$
million this year. As with Billingham's existing products, the cost of goods for the products produced by the XC is expected to be
of their sale price. The increased production will require additional inventory on hand of
$
million to be added in year and depleted in year
bullet
Human Resources: The expansion will require additional sales and administrative personnel at a cost of
$
million per year.
bullet
Accounting: The XC will be depreciated via the straightline method over theyear life of the machine. Receivables are expected to be
of revenues and payables to be
of the cost of goods sold. Billingham's marginal corporate tax rate is
a Determine the incremental earnings from the purchase of the XCb Determine the free cash flow from the purchase of the XC
c If the appropriate cost of capital for the expansion is
compute the NPV of the purchase.
d While the expected new sales will be
$
million per year from the expansion, estimates range from
$
million to
$ $
million. What is the NPV in the worst case? In the best case?
e
What is the breakeven level of new sales from the expansion? What is the breakeven level for the cost of goods sold as a percentage of sales?
f Billingham could instead purchase the XC which offers even greater capacity. The cost of the XC is
$
million. The extra capacity would not be useful in the first two years of operation, but would allow for additional sales in years
dash
What level of additional salesabove the
$
million expected for the XC per year in those years would justify purchasing the larger machine?
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