Problem 7.

24
Billingham 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 partia
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 10-year life of the machine.
Operations: The disruption caused by the installation will decrease sales by $5 million this year. Once
the machine is operating next year, the cost of goods for the products produced by the XC-750 is expecte4d to be 70% of their
Human Resources: The expansion will require additional sales and administrative personnel at a cost of
$2 million per year.
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 10% of the cost of goods
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 10%, compute the NPV of the purchase.
d. While the expected sales will be $10 million per year from the expansion, estimates range from $8 million to $12 million.
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?
f. Billingham could instead purchase the XC-900, which offers greater capacity. The cost of the XC-900 is $4 million. The ext
ngham Packaging is considering expanding its production capacity by purchasing a new machine, the
750. The cost of the XC-750 is $2.75 million. Unfortunately, installing this machine will take several months and will partially disrupt produ
rketing: Once the XC-750 is operating next year, the extra capacity is expected to generate $10
ion per year in additional sales, which will continue for the 10-year life of the machine.
rations: The disruption caused by the installation will decrease sales by $5 million this year. Once
machine is operating next year, the cost of goods for the products produced by the XC-750 is expecte4d to be 70% of their sales price. Th
man Resources: The expansion will require additional sales and administrative personnel at a cost of
million per year.
ounting: The XC-750 will be depreciated via the straight-line method over the 10-year life of the
chine. The firm expects receivables from the new sales to be 15% of revenues and payables to be 10% of the cost of goods sold. Billingham
Determine the incremental earnings from the purchase of the XC-750.
Determine the free cash flow from the purchase of the XC-750.
If the appropriate cost of capital for the expansion is 10%, compute the NPV of the purchase.
While the expected sales will be $10 million per year from the expansion, estimates range from $8 million to $12 million. What is the NPV
What is the break-even level of new sales from the expansion? What is the break-even level for the cost of goods sold?
Billingham could instead purchase the XC-900, which offers greater capacity. The cost of the XC-900 is $4 million. The extra capacity wou
hs and will partially disrupt production. The firm has just completed a $50,000 feasibility study to analyze the decision to buy the XC-750,

o be 70% of their sales price. The increase production will require additional inventory on hand of $1 million to be added in year 0 and de

the cost of goods sold. Billingham’s marginal corporate tax rate is 35%.

n to $12 million. What is the NPV in the worst case? In the best case?
of goods sold?
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. Wh
he decision to buy the XC-750, resulting in the following estimates:

n to be added in year 0 and depleted in year 10.

itional 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 ju
er year in those years would justify purchasing the larger machine?
Sales revenues, yrs 1-10 10,000,000
Cost of goods sold 70.000%
SGA Expenses 2,000,000
Capital Expenditure 2,750,000
Tax rate 35%
Cost of capital 10%
Receivables % of sales 15%
Payables % of CGS 10%
0 1 2 3 4 5 6 7 8
Revenues (5,000,000) 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Cost of goods sold 3,500,000 (7,000,000) (7,000,000) (7,000,000) (7,000,000) (7,000,000) (7,000,000) (7,000,000) (7,000,000)
SGA Expenses (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000)
Depreciation (275,000) (275,000) (275,000) (275,000) (275,000) (275,000) (275,000) {275,000)
EBIT (1,500,000) 725,000 725,000 725,000 725,000 725,000 725,000 725,000 725,000
Taxes 525,000 (253,750) (253,750) (253,750) (253,750) (253,750) (253,750) (253,750) (253,750)
Unlevered Net Income (975,000) 471,250 471,250 471,250 471,250 471,250 471,250 471,250 471,250

Cash Flow Calculations

Add: Depreciation (2,750,000) 275,000 275,000 275,000 275,000 275,000 275,000 275,000 275,000
Less: Capital Expenditures

Less: Additions to NWC (600,000) (1,200,000) 0 0 0 0 0 0 0

Free Cash Flow (4,325,000) (453,750) 746,250 746,250 746,250 746,250 746,250 746,250 746,250
NPV (164,587)

Net Working Capital

Calculations
0 1 2 3 4 5 6 7 8
Receivables (750,000) 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Payables 350,000 (700,000) (700,000) (700,000) (700,000) (700,000) (700,000) (700,000) (700,000)
Inventory 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
NWC 600,000 1,800,000 1,800,000 1,800,000 1,800,000 1,800,000 1,800,000 1,800,000 1,800,000

NPV Sensitivity Analysis to

Sales
8,000,000 8,500,000 9,000,000 9,500,000 10,000,000 10,500,000 11,000,000 11,500,000 12,000,000
(164,587) (2,471,593) (1,894,842) (1,318,090) (741,339) (164,587) 412,164 988,915 1,565,667 2,142,418
Break-even value of sales 10,142,685
NPV Sensitivity Analysis to CGS %
68.0% 68.5% 69.0% 69.5% 70.0% 70.5% 71.0% 71.5% 72.0%

(164,587) 558,943 378,061 197,178 16,295 (164,587) (345,470) (526,353) (707,236) (888,118)
Break-even value of CGS % 69.545%
 9 10 11
10,000,000 10,000,000
(7,000,000) (7,000,000)
(2,000,000) (2,000,000)
(275,000) (275,000)
725,000 725,000
(253,750) (253,750)
471,250 471,250

275,000 275,000

0 1,000,000 800,000
746,250 1,746,250 800,000

9 10 11
1,500,000 1,500,000
(700,000) (700,000)
1,000,000 0
1,800,000 800,000
Sales revenues, yrs 1-10 10,000,000
Cost of goods sold 70.000%
SGA Expenses 2,000,000
Capital Expenditure 4,000,000
Tax rate 35%
Cost of capital 10%
Receivables % of sales 15%
Payables % of CGS 10%
Incremental sales, yrs 3-10 1,384,281

0
1 2 3 4 5 6 7 8

Revenues (5,000,000) 10,000,000 10,000,000 11,384,281 11,384,281 11,384,281 11,384,281 11,384,281 11,384,281
Cost of goods sold 3,500,000 (7,000,000 (7,000,000} (7,968,997) (7,968,997) (7,968,997) (7,968,997) (7,968,997) (7,968,997)
}
SGA Expenses (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000)
Depreciation (400,000) (400,000) (400,000) (400,000) (400,000) (400,000) (400,000) (400,000)
EBIT (1,500,000) 600,000 600,000 1,015,284 1,015,284 1,015,284 1,015,284 1,015,284 1,015,284
Taxes 525,000 (210,000) (210,000) (355,350) (355,350) (355,350) (355,350) (355,350) (355,350)
Unlevered Net Income (975,000) 390,000 390,000 659,935 659,935 659,935 659,935 659,935 659,935

Cash Flow Calculations

Add: Depreciation 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
Less: Capital Expenditures (4,000,000)
Less: Additions to NWC (600,000) (1,200,000) 0 (110,742) 0 0 0 0 0
Free Cash Flow (5,575,000) (410,000) 790,000 949,192 1,059,935 1,059,935 1,059,935 1,059,935 1,059,935
NPV 0

Net Working Capital

Calculations
0 1 2 3 4 5 6 7 8
Receivables (750,000) 1,500,000 1,500,000 1,707,642 1,707,642 1,707,642 1,707,642 1,707,642 1,707,642
Payables 350,000 (700,000) (700,000) (796,900) (796,900) (796,900) (796,900) (796,900) (796,900)
Inventory 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
NWC 600,000 1,800,000 1,800,000 1,910,742 1,910,742 1,910,742 1,910,742 1,910,742 1,910,742
 9 10 11

11,384,281 11,384,281
(7,968,997) (7,968,997)
(2,000,000) (2,000,000)
(400,000} (400,000)
1,015,284 1,015,284
(355,350) (355,350)
659,935 659,935

400,000 400,000

0 1,000,000 910,742
1,059,935 2,059,935 910,742

9 10 11
1,707,642 1,707,642
(796,900) (796,900)
1,000,000 0
1,910,742 910,742