International Paper (IP), a Memphis based paper conglomerant, is considering expanding its production capacity by purchasing a new machine, the TJ-50. The cost of the TJ-750 is $2.75 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 TJ-50, resulting in the following estimates:

Marketing: Once the TJ-50 is operating next year, the extra capacity is expected to

generate $10 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. Once the machine is operating next year, the cost of goods for the products produced

by the TJ-50 is expected to be 70% of their sale price. The increased production will

require additional inventory on hand of $1 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 TJ-50 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 10% of the cost of goods sold. IP's marginal corporate tax rate is

35%.

a. Determine the incremental earnings from the purchase of the TJ-50.

b. Determine the free cash flow from the purchase of the TJ-50.

c. If the appropriate cost of capital for the expansion is 10%, compute the NPV of the

purchase.

d. While the expected new sales will be $10 million per year from the expansion, estimates

range from $8 million to $12 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 break-even level

for the cost of goods sold?

f. IP could instead purchase the TJ-90, which offers even greater capacity. The cost

of the TJ-90 is $4 million. The extra capacity would not be useful in the first two years of

operation, but would allow for additional sales in years 3-10. What level of additional sales

(above the $10 million expected for the TJ-50) per year in those years would justify

purchasing the larger machine?