Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the $xC-750.$ The cost of the XC$-750$ is $$2\mathrm{.}73$ million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $$50,000$ 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\mathrm{.}00$ 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 $$5\mathrm{.}09$ million this year. As with Billingham's existing products, the cost of goods for the products produced by the XC$-750$ is expected to be $72\%$ of their sale price. The increased production will also require increased inventory on hand of $$1\mathrm{.}09$ million during the life of the project, including year $0.$

Human Resources: The expansion will require additional sales and admini$$trative personnel at a cost of $$1\mathrm{.}97$ 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 $15\%$ of revenues and payables to be $11\%$ of the cost of goods

Year

Sales

Cost of Goods Sold

Selling, General, and Administrative Expenses

Depreciation

EBIT

Taxes at $21\%$

Unlevered Net Income

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 $15\%$ of revenues and payables to be $11\%$ of the cost of goods sold. Billingham's marginal corporate tax rate is $21\%.$

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 $9\mathrm{.}7\%,$ compute the NPV of the purchase.

d$.$ While the expected new sales will be $$10\mathrm{.}05$ million per year from the expansion, estimates range from $$7\mathrm{.}90$ million to $$12\mathrm{.}10$ 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 $$4\mathrm{.}03$ million. The extra capacity would not be useful in the first two years of operation, but would allow for additional sales in years $3$ through $10.$ What level of additional sales $($above the $$10\mathrm{.}00$ million expected for the $xC-750)$ per year in those years would justify purchasing the larger machine?

Year

$0$

$1-10$

Sales

$$

Cost of Goods Sold

Selling, General, and Administrative Expenses

Depreciation EBIT

Taxes at $21\%$

Unlevered Net Income