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Buckingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC750 is $2.25 million. Unfortunately, installing
Buckingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC750 is $2.25 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 XC750, resulting in the following estimates: Marketing: Once the XC750 is operating next year, the extra capacity is expected to generate $10.5 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 million this year (year 0 ). Once the machine is operating next year, the cost of goods for the products produced by the XC750 is expected to be 70% of their sale price. The increased production will require additional inventory on hand of $2.0 million, to be added in year 0 and depleted in year 10. Human Resources: The expansion will require additional sales and administrative personnel at a cost of $2 million per year. Accounting: The XC750 has a CCA rate of 35% and no salvage value is expected. The firm expects receivables from the new sales to be 10% of revenues and payables are expected to be 10% of the cost of goods sold. Buckingham's marginal corporate tax rate is 33%. a. Determine the incremental earnings (using CCA ) from the purchase of the XC750. b. Determine the free cash flow (including all CCA tax shield effects) from the purchase of the XC-750 for the first 10 years. (Hint: include the impact in year 11.)
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