Question: Buckingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $2.75 million. Unfortunately, installing
Buckingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-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 XC-750, resulting in the following estimates:
■ Marketing: Once the XC-750 is operating next year, the extra capacity is expected to generate $10 million per year in additional sales, which will continue for the ten-year life of the machine.
■ Operations: The disruption caused by the installation will decrease sales by $5 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 70% of their sale price. The increased production will require additional inventory of $1M, 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 XC-750 has a CCA rate of 30%, and no salvage is expected. The firm expects receivables from the new sales to be 15% of revenues and payables to be 10% of the cost of goods sold. Buckingham's marginal corporate tax rate is 35%.
a. Determine the incremental earnings (using CCA) from the purchase of the XC-750.
b. Determine the free cash flow from the purchase of the XC-750 for the first 10 years.
c. If the appropriate cost of capital for the expansion is 10%, compute the NPV of the purchase (including all CCA tax shield effects).
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 NPV-break-even level of new sales from the expansion? What is the NPV-break-even level for the cost of goods sold?
f. Buckingham could instead purchase the XC-900, which offers even greater capacity. The cost of the XC-900 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 XC-750) per year in those years would justify purchasing the larger machine?
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Tax rate 3500 Cost of goods as a of sales 7000 First year sales value 1000000 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Sales revenues 500000 1000000 1000000 1000000 1000000 1000000 1000000 1000000 1000000 1000000 1000000 Cost of goods sold 350000 700000 700000 700000 700000 700000 700000 700000 700000 700000 700000 S G A expenses 200000 200000 200000 200000 200000 200000 200000 200000 200000 200000 CCA using eq 71 and 72 41250 70125 49088 34361 24053 16837 11786 8250 5775 4043 EBIT 150000 58750 29875 50913 65639 75947 83163 88214 91750 94225 95957 Taxes at 35 52500 20563 10456 17819 22974 26581 29107 30875 32112 32979 33585 a Unlevered Net Income 97500 38188 19419 33093 42665 49366 54056 57339 59637 61246 62372 CCA using eq 71 and 72 41250 70125 49088 34361 24053 16837 11786 8250 5775 4043 Capital Expenditures 275000 Net Working Capital Calculation Receivables at 15 75000 150000 150000 150000 150000 150000 150000 150000 150000 150000 150000 000 Payables at 10 35000 70000 70000 70000 70000 70000 70000 70000 70000 70000 70000 000 Inventory 100000 100000 ... View full answer
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