Question
Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $ 2.77$2.77 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
$ 2.77$2.77
million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a
$ 49 comma 000$49,000
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$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
$ 4.91$4.91
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
74 %74%
of their sale price. Theincreased production will also require increased inventory on hand of
$ 1.19$1.19
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
$ 1.99$1.99
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
15 %15%
of revenues and payables to be
11 %11%
of the cost of goods sold. Billingham's marginal corporate tax rate is
35 %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
9.6 %9.6%,
compute the NPV of the purchase.d. While the expected new sales will be
$ 10.00$10.00
million per year from the expansion, estimates range from
$ 8.05$8.05
million to
$ 11.95$11.95
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
$ 3.91$3.91
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$10.00
million expected for the XC-750) per year in those years would justify purchasing the larger machine?
a. Determine the incremental earnings from the purchase of the XC-750.
Calculate the incremental earnings from the purchase of the XC-750 below (with vs. without XC?750):(Round to the nearest dollar.)
Incremental Effects | ||||
Year |
| 0 | ||
Sales Revenues | $ |
| ||
Cost of Goods Sold | $ |
| ||
S, G, and A Expenses | $ |
| ||
Depreciation | $ |
| ||
EBIT | $ |
| ||
Taxes at 35% | $ |
| ||
Unlevered Net Income | $ |
|
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