Problem 9-30

Billingham Packaging is considering expanding its production capacity by purchasin

million. Unfortunately, installing this machine will take several months and will parti
feasibility study to analyze the decision to buy the XC-750, resulting in the following

■ Marketing: Once the XC-750 is operating next year, the extra capacity is expected
continue for the ten-year life of the machine.
■
Operations: The disruption caused by the installation will decrease sales by $5 m
goods for the products produced by the XC-750 is expected to be 70% of their sal
inventory on hand of $1 million during the life of the project.
■ Human Resources: The expansion will require additional sales and administrative
■
Accounting: The XC-750 will be depreciated via the straight-line method over the
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 th
d. While the expected new sales will be $10 million per year from the expansion, es
the worst case? In the best case?
e. What is the break-even level of new sales from the expansion? What is the break-
f. Billingham could instead purchase the XC-900, which offers even greater capacit
not be useful in the first two years of operation, but would allow for additional sa
million expected for the XC-750) per year in those years would justify purchasing
on capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $2.75
eral months and will partially disrupt production. The firm has just completed a $50,000
resulting in the following estimates:

extra capacity is expected to generate $10 million per year in additional sales, which will

l decrease sales by $5 million this year. As with Billingham’s existing products, the cost of
ted to be 70% of their sale price. The increased production will also require increased
ject.
sales and administrative personnel at a cost of $2 million per year.

ight-line method over the ten-year life of the machine. The firm expects receivables from
10% of the cost of goods sold. Billingham’s marginal corporate tax rate is 35%.
the XC-750.
C-750.
%, compute the NPV of the purchase.
r from the expansion, estimates range from $8 million to $12 million. What is the NPV in

nsion? What is the break-even level for the cost of goods sold?

fers even greater capacity. The cost of the XC-900 is $4 million. The extra capacity would
d allow for additional sales in years 3–10. What level of additional sales (above the $10
would justify purchasing the larger machine?
 Tax rate 35.0%
Cost of goods as a % of sales 70.0% input here
First year sales value 10,000.00

Year 0 Year 1 Year 2

Sales revenue (5,000) 10,143 10,143
Cost of goods sold 3,500 (7,100) (7,100)
Additional personnel (2,000) (2,000)
Depreciation (275) (275)
Equals net operating income (1,500) 768 768
Minus income tax (525) 269 269
a. Equals Unlevered Net income (975) 499 499
Plus depreciation 275 275
Capital Expenditures (2,750)
Add to NWC (600) (1,211) 0
b. Free cash flow (4,325) (437) 774
c. Cost of capital 0
NPV (0)

Net Working Capital Calculations:

Increased receivables (750) 1,521 1,521
Increased payables 350 (710) (710)
Increased inventory 1,000 1,000 1,000
NWC 600 1,811 1,811

d. Sales revenue NPV

Base case (0)
High revenue 12,000.00 (0)
Low revenue 8,000.00 (0)
Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
10,143 10,143 10,143 10,143 10,143 10,143
(7,100) (7,100) (7,100) (7,100) (7,100) (7,100)
(2,000) (2,000) (2,000) (2,000) (2,000) (2,000)
(275) (275) (275) (275) (275) (275)
768 768 768 768 768 768
269 269 269 269 269 269
499 499 499 499 499 499
275 275 275 275 275 275

0 0 0 0 0 0
774 774 774 774 774 774

1,521 1,521 1,521 1,521 1,521 1,521

(710) (710) (710) (710) (710) (710)
1,000 1,000 1,000 1,000 1,000 1,000
1,811 1,811 1,811 1,811 1,811 1,811
Year 9 Year 10 Year 11
10,143 10,143
(7,100) (7,100)
(2,000) (2,000)
(275) (275)
768 768 0
269 269 0
499 499 0
275 275 0

0 1,000 811
774 1,774 811

1,521 1,521 0
(710) (710) 0
1,000 0 0
1,811 811 0
 Tax rate 35.0%
Cost of goods as a % of sales 69.5% this input driven by cell c33
First year sales value 10,000.00

Year 0 Year 1 Year 2

Sales revenue (5,000) 10,000 10,000
Cost of goods sold 3,477 (6,955) (6,955)
Additional personnel (2,000) (2,000)
Depreciation (275) (275)
Equals net operating income (1,523) 770 770
Minus income tax (533) 270 270
a. Equals Unlevered Net income (990) 501 501
Plus depreciation 275 275
Capital Expenditures (2,750)
Add to NWC (598) (1,207) 0
b. Free cash flow (4,338) (431) 776
c. Cost of capital 0
NPV 0

Net Working Capital Calculations:

Increased receivables (750) 1,500 1,500
Increased payables 348 (695) (695)
Increased inventory 1,000 1,000 1,000
NWC 598 1,805 1,805

d. Sales revenue NPV

Breakeven v
Base case 0 calculated us
High revenue 12,000.00 2,142 Excel's solve
Low revenue 8,000.00 (2,472)
Breakeven cost of goods sold
with original assumptions 69.55%
y cell c33

Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

10,000 10,000 10,000 10,000 10,000 10,000
(6,955) (6,955) (6,955) (6,955) (6,955) (6,955)
(2,000) (2,000) (2,000) (2,000) (2,000) (2,000)
(275) (275) (275) (275) (275) (275)
770 770 770 770 770 770
270 270 270 270 270 270
501 501 501 501 501 501
275 275 275 275 275 275

0 0 0 0 0 0
776 776 776 776 776 776

1,500 1,500 1,500 1,500 1,500 1,500

(695) (695) (695) (695) (695) (695)
1,000 1,000 1,000 1,000 1,000 1,000
1,805 1,805 1,805 1,805 1,805 1,805

Breakeven values are

calculated using
Excel's solver function.
Year 9 Year 10 Year 11
10,000 10,000
(6,955) (6,955)
(2,000) (2,000)
(275) (275)
770 770 0
270 270 0
501 501 0
275 275 0

0 1,000 805
776 1,776 805

1,500 1,500 0
(695) (695) 0
1,000 0 0
1,805 805 0
 Tax rate 35.0%
Cost of goods as a % of sales 70.0%
First year sales value 10,142.69 this input driven by cell c35

Year 0 Year 1 Year 2

Sales revenue (5,000) 10,143 10,143
Cost of goods sold 3,500 (7,100) (7,100)
Additional personnel (2,000) (2,000)
Depreciation (275) (275)
Equals net operating income (1,500) 768 768
Minus income tax (525) 269 269
a. Equals Unlevered Net income (975) 499 499
Plus depreciation 275 275
Capital Expenditures (2,750)
Add to NWC (600) (1,211) 0
b. Free cash flow (4,325) (437) 774
c. Cost of capital 0
NPV 0

Net Working Capital Calculations:

Increased receivables (750) 1,521 1,521
Increased payables 350 (710) (710)
Increased inventory 1,000 1,000 1,000
NWC 600 1,811 1,811

d. Sales revenue NPV

Base case 0
High revenue 12,000.00 2,142 Breakeven valu
calculated using
Low revenue 8,000.00 (2,472) Excel's solver
e. Breakeven sales with original function.
assumptions
Breakeven cost of goods sold
with original assumptions 10,142.69
by cell c35

Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

10,143 10,143 10,143 10,143 10,143 10,143
(7,100) (7,100) (7,100) (7,100) (7,100) (7,100)
(2,000) (2,000) (2,000) (2,000) (2,000) (2,000)
(275) (275) (275) (275) (275) (275)
768 768 768 768 768 768
269 269 269 269 269 269
499 499 499 499 499 499
275 275 275 275 275 275

0 0 0 0 0 0
774 774 774 774 774 774

1,521 1,521 1,521 1,521 1,521 1,521

(710) (710) (710) (710) (710) (710)
1,000 1,000 1,000 1,000 1,000 1,000
1,811 1,811 1,811 1,811 1,811 1,811

Breakeven values are

calculated using
Excel's solver
function.
Year 9 Year 10 Year 11
10,143 10,143
(7,100) (7,100)
(2,000) (2,000)
(275) (275)
768 768 0
269 269 0
499 499 0
275 275 0

0 1,000 811
774 1,774 811

1,521 1,521 0
(710) (710) 0
1,000 0 0
1,811 811 0
 Tax rate 35.0%
Cost of goods as a % of 70.0% This value is calculated using
First year sales value 10,000 set NPV = 0 (cell C 20) by cha
c29. The remaining values wil

Year 0 Year 1 Year 2 Year 3

f. Sales revenue (5,000) 10,000 10,000 11,384
Cost of goods sold 3,500 (7,000) (7,000) (7,969)
Additional personnel (2,000) (2,000) (2,000)
Depreciation (400) (400) (400)
Equals net operating i (1,500) 600 600 1,015
Minus income tax (525) 210 210 355
Equals Unlevered Net (975) 390 390 660
Plus depreciation 400 400 400
Capital Expenditures (4,000)
Add to NWC (600) (1,200) 0 (111)
Free cash flow (5,575) (410) 790 949
Cost of capital 0
NPV 0

Net Working Capital Calculations:

Increased receivables (750) 1,500 1,500 1,708
Increased payables 350 (700) (700) (797)
Increased inventory 1,000 1,000 1,000 1,000
NWC 600 1,800 1,800 1,911
Breakeven sales with
more expensive
machine 11,384
needed to break even
with more expensive
machine 1,384
is calculated using Goal Seek -
0 (cell C 20) by changing cell
emaining values will adjust.

Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

11,384 11,384 11,384 11,384 11,384 11,384 11,384
(7,969) (7,969) (7,969) (7,969) (7,969) (7,969) (7,969)
(2,000) (2,000) (2,000) (2,000) (2,000) (2,000) (2,000)
(400) (400) (400) (400) (400) (400) (400)
1,015 1,015 1,015 1,015 1,015 1,015 1,015
355 355 355 355 355 355 355
660 660 660 660 660 660 660
400 400 400 400 400 400 400

0 0 0 0 0 0 1,000
1,060 1,060 1,060 1,060 1,060 1,060 2,060

1,708 1,708 1,708 1,708 1,708 1,708 1,708

(797) (797) (797) (797) (797) (797) (797)
1,000 1,000 1,000 1,000 1,000 1,000 0
1,911 1,911 1,911 1,911 1,911 1,911 911
Year 11

0
0
0
0

911
911

0
0
0
0