Dimension Company is considering expanding its production capacity by purchasing a new machine, the Z-500. The cost of the Z-500 is 8.25 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 Z-500 and the impact that this will have on costs and revenues.

Once the Z-500 is operating next year, the extra capacity is expected to generate 30 million per year in additional sales, which will continue for the 10-year life of the machine. However, the disruption caused by the installation will decrease sales by 15 million this year and the expansion will require additional sales and administrative personnel at a cost of 6 million per year. The cost of goods sold is in all cases expected to be 70% of the sales price and the increase in volume will require an additional 1.8 million of working capital this year and 3.6 million next year. Of this total of 5.4 million, 3 million is expected to be recovered in year 10 and the remainder a year later.

The Z-500 will be depreciated via the straight-line method over the 10-year life of the machine. IPCs marginal corporate tax rate is 35%.

1. What are the incremental earnings from the purchase of the Z-500?
2. What are the incremental free cash flows from the purchase of the Z-500?
3. If the appropriate cost of capital for the expansion is 10%, what is the NPV of the purchase?

Finally, IPC wishes to consider the possibility of financing the project partly with debt. The company considers that the project could support a debt-to-value ratio of 45% and the borrowing rate would be 5%.

4. If the project is financed in this way, what is the NPV of the project to purchase the Z-500?
5. Explain the relationship between the NPVs you have calculated in parts (c.) and (d).