QUESTION 1
Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $ 2.76 million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $ 49 comma 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 $ 10.05 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 $ 5.04 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 67 % of their sale price. The increased production will also require increased inventory on hand of $ 1.17 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 $ 2.02 million per year. bullet 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 9 % of the cost of goods sold. Billingham's marginal corporate tax rate is 35 %. 1. If the appropriate cost of capital for the expansion is 10.1 %, compute the NPV of the purchase. d. While the expected new sales will be $ 10.05 million per year from the expansion, estimates range from $ 7.95 million to $ 12.15 million. What is the NPV in the worst case? In the best case? Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $ 2.76 million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $ 49 comma 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 $ 10.05 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 $ 5.04 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 67 % of their sale price. The increased production will also require increased inventory on hand of $ 1.17 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 $ 2.02 million per year. bullet 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 9 % of the cost of goods sold. Billingham's marginal corporate tax rate is 35 %. 1. If the appropriate cost of capital for the expansion is 10.1 %, compute the NPV of the purchase. d. While the expected new sales will be $ 10.05 million per year from the expansion, estimates range from $ 7.95 million to $ 12.15 million. What is the NPV in the worst case? In the best case
