Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $2.77 million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $48,000 feasibility study to analyze the decision to buy the XC-750, resulting in the following estimates:
Marketing: Once the XC-750 is operational next year, the extra capacity is expected to generate $10.20 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 $4.98 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 68% of their sale price. The
increased production will also require increased inventory on hand of $1.09 million during the life of the project, including year 0.
Human Resources: The expansion will require additional sales and administrative personnel at a cost of $2.01 million per year.
Accounting: The XC-750 will be depreciated via thestraight-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 .
a. Determine the incremental earnings from the purchase of theXC-750.
b. Determine the free cash flow from the purchase of theXC-750.
c. If the appropriate cost of capital for the expansion is 9.6%, compute the NPV of the purchase.
d. While the expected new sales will be $10.20 million per year from the expansion, estimates range from $8.25 million to $12.15 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 breakeven level for the cost of goods sold?
f. Billingham could instead purchase the XC-900, which offers even greater capacity. The cost of the XC-900 is $4.07 million. The extra capacity would not be useful in the first two years ofoperation, but would allow for additional sales in years 3 through 10. What level of additional sales (above the $10.20 million expected for the XC-750) per year in those years would justify purchasing the larger machine?
