Question

Billingham Packaging is considering expanding its production capacity by purchasing a new​ machine, the​ XC-750. The cost of the​ XC-750 is $ 2.84 million.​ Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $ 47000 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 $ 10.00 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 $ 5.01 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 an 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 16 % of revenues and payables to be 11 % of the cost of goods sold.​ Billingham's marginal corporate tax rate is 35 %.

a. Determine the incremental earnings from the purchase of the​ XC-750.

Calculate the incremental earnings from the purchase of the​ XC-750 below​ (with vs. without​ XC?750): ​(Round to the nearest​ dollar.)

Year	0	1-10
Sales Revenues	$	$
Cost of Goods Sold	$	$
S, G, and A Expenses	$	$
Depreciation	$	$
EBIT	$	$
Taxes at 35%	$	$
Unlevered Net Income	$	$

b. Determine the free cash flow from the purchase of the​ XC-750.

Calculate the free cash flow from the purchase of the​ XC-750 below​ (with vs. without​ XC?750): ​ (Note: the change in net working capital for year 0 is equal to the sum of the change in accounts receivable due to the decrease in​ sales, the change in inventory due to the increase in inventory starting in year​ 0, and the change in accounts payable due to the decrease in cost of goods​ sold.) (Round to the nearest​ dollar.)

Year	0	1	2-9	10	11
Unlevered Net Income	$	$	$	$	$
Depreciation	$	$	$	$	$
Capital Expenditures	$	$	$	$	$
Change on Net Working Capital	$	$	$	$	$
Free cash flow	$	$	$	$	$

  

c. If the appropriate cost of capital for the expansion is 10.3 %​, compute the NPV of the purchase.
The NPV of the purchase is ​$______. ​(Round to the nearest​ dollar.)

d. While the expected new sales will be $ 10.00 million per year from the​ expansion, estimates range from $ 8.10 million to $ 11.90 million. What is the NPV in the worst​ case? In the best​ case?

The NPV of the purchase for sales of $ 8.10 million is ​$______. ​(Round to the nearest​ dollar.)
The NPV of the purchase for sales of $ 11.90 million is ​$_______. ​(Round to the nearest​ dollar.)

e. What is the​ break-even level of new sales from the​ expansion?
The​ break-even level of new sales from the expansion is ​$_____. ​(Round to the nearest​ dollar.)

What is the breakeven level for the cost of goods​ sold?
The breakeven level for the cost of goods sold is _____% of sales. (Round to two decimal​ places.)

f. Billingham could instead purchase the​ XC-900, which offers even greater capacity. The cost of the​ XC-900 is $ 3.92 million. The extra capacity would not be useful in the first two years of​ operation but would allow for additional sales in years 3 through 10.
What level of additional sales​ (above the $ 10.00 million expected for the​ XC-750) per year in those years would justify purchasing the larger​ machine?

The additional sales would need to be ​$______. ​(Round to the nearest​ dollar.)

Answer 1

a]

incremental earnings before tax = additional sales - cost of goods sold - additional costs - depreciation

incremental earnings after tax = incremental earnings before tax - taxes

b]

Operating cash flow (FCF) each year = incremental income after tax + depreciation

FCF in year 0 = -(cost of machine + increase in inventory + incremental income after tax)

Decrease in contribution in year 0 =   decreased sales * (1 – cost of goods %)

The amount spent on feasibility study is a sunk cost as it is incurred in the past, and cannot be recovered. It should not be considered in the incremental cash flow analysis.

FCF in year 2 = OCF – increase in NWC (net working capital)

Increase in NWC = increase in accounts receivable – increase in accounts payable

FCF in years 2 to 9 = OCF

FCF in year 10 = OCF + terminal cash flow

Terminal cash flow = recovery of inventory + recovery of NWC

c]

NPV is calculated using NPV function in Excel

NPV is -$2,301,398

d]

NPV in the worst case is -$4,096,074

NPV in the best case is -$506,722