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

$49,000

feasibility study to analyze the decision to buy the XC-750, resulting in the following estimates:

Marketing: Once the XC-750 is operational next year, the extra capacity is expected to generate

$10.10

million per year in additional sales, which will continue for the 10-year life of the machine.

Operations: The disruption caused by the installation will decrease sales by

$4.97

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

72%

of their sale price. Theincreased production will also require increased inventory on hand of

$1.03

million during the life of the project, including year 0.

Human Resources: The expansion will require additional sales and administrative personnel at a cost of

$2.02

million per year.

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%.

Billingham could instead purchase the XC-900, which offers even greater capacity. The cost of the XC-900 is

$3.99

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.

a. What kind of real option does the XC-900 machine provide to Billingham?

b. If Billingham knows that it can sell the XC-750 to another firm for

$2.17

million in two years, what kind of real option would that provide?

a. What kind of real option does the XC-900 machine provide to Billingham?(Select all the choices that apply.)

A.

If it would be beneficial to expand production, Billingham will increase production with the XC-900.

B.

If it would be better if production remains the same, Billingham is under no obligation to utilize all of the XC-900 production capacity.

C.

The XC-900 allows Billingham the option to expand production starting in year 3.

D.

The expansion will require additional sales and administrative personnel.