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 $45,000 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 $10.05 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 $5.09 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 72% of their sale price. The increased production will also require increased inventory on hand of $1.11 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 $1.91 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 9% of the cost of goods sold. Billingham's marginal corporate tax rate is 21%. d. While the expected new sales will be $10.05 million per year from the expansion, estimates range from $7.95 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 $3.97 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 $10.05 million expected for the XC-750) per year in those years would justify purchasing the larger machine?

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 $45,000 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 $10.05 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 $5.09 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 72% of their sale price. The increased production will also require increased inventory on hand of $1.11 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 $1.91 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 9% of the cost of goods sold. Billingham's marginal corporate tax rate is 21%. d. While the expected new sales will be $10.05 million per year from the expansion, estimates range from $7.95 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 $3.97 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 $10.05 million expected for the XC-750) per year in those years would justify purchasing the larger machine?

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 15E: Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided...

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