Buckingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is

$ 2.73

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:

bullet

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.

bullet

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

$ 4.95

million this year. As with Buckingham's existing products, the cost of goods for the products produced by the XC-750 is expected to be

67 %

of their sale price. The

increased production will also require increased inventory on hand of

$ 1.11

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

million per year.

bullet

Accounting: The XC-750 has a CCA rate of 30%, and no salvage value is expected. The firm expects receivables from the new sales to be

16 %

of revenues and payables to be

10 %

of the cost of goods sold. Buckingham's marginal corporate tax rate is

35 %

If Buckingham knows that it can sell the XC-750 to another firm for

$ 2.01

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

A.

This provides Buckingham the option to abandon the investment.

B.

Buckingham will no longer depreciate the machine.

C.

The decreased production will also require decreased inventory.

D.

The firm can recover the feasibility study cost.