Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is

$2.65

million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a

$46,000

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

$10.2

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

$5.04

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

75%

of their sale price. The increased production will also require increased inventory on hand of

$1.01

million during the life of the project. The increased production will require additional inventory of

$1.01

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

$1.97

million per year.

Accounting: The XC-750 will be depreciated via the straight-line method in years 1-10. Receivables are expected to be

16%

of revenues and payables to be

10%

of the cost of goods sold. Billingham's marginal corporate tax rate is

15%.

a. Determine the incremental earnings from the purchase of the XC-750. b. Determine the free cash flow from the purchase of the XC-750.

c. If the appropriate cost of capital for the expansion is

9.5%,

compute the NPV of the purchase.

d. While the expected new sales will be

$10.2

million per year from the expansion, estimates range from

$8.1

million to

$12.3

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 as a percentage of sales?

f. Billingham could instead purchase the XC-900, which offers even greater capacity. The cost of the XC-900 is

$3.94

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

$10.2

million expected for the XC-750) per year in those years would justify purchasing the larger machine?