Question

Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $2.85 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 operational next year, the extra capacity is expected to generate $10.20 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 $5.04 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 74% of their sale price. The increased production will also require increased inventory on hand of $1.09 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 $2.03 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 sold. Billingham's marginal corporate tax rate is 35%. 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 10.2%, compute the NPV of the purchase. 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.) Incremental Effects Year 1-10 Sales Revenues Cost of Goods Sold S, G, and A Expenses Depreciation EBIT 66 67 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 XC2750): (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.) Incremental Effects

Answer 1

a).

Formula Sales disruption in Year 0 74%*s 0 -5040000 3729600 Time(n) Sales revenue (s) COGS SG&A Depreciation (D) EBIT Tax @ 35% Unlevered net income (NI) 1-10 10200000 -7548000 -2030000 -285000 337000 -117950 219050 Cost of machine/10 S-COGS-SG&A-D 35% EBIT EBIT-Tax -1310400 458640 -851760

b). Net working capital calculation:

Formula 10 15%*S 10%*COGS I+R-P NWCn-1-NWCn Time (n) Inventory (1) Receivables ('R) Payables (P) NWC Increase in NWC 1090000 -756000 372960 706960 -706960 1090000 1530000 -754800 1865200 -1158240 2-9 1090000 1530000 -754800 1865200 0 1530000 -754800 775200 1090000 7752001

Free cash flow calculation:

Formula 0 -851760 1 219050 285000 2-9 219050 285000 10 219050 285000 Time (n) Unlevered net income (NI) Depreciation (D) Capital expenditure (CE) Change in NWC Free Cash Flow (FCF) -2850000 -706960 -4408720 1158240 -654190 1090000 1594050 7752001 775200 NI+D-CE-Change in NWC 504050

c). NPV = -1,710,013

Formula Time (n) Free Cash Flow (FCF) Discount rate @ 10.2% PV of FCF NPV 0 -4408720 1.000 -4408720 -1710013 1 -654190 0.907 -593639 2 3 504050504050 0.823 0.747 415060 376642 4 5 6 504050 504050504050 0.678 0.615 0.558 341780310146281439 7 504050 0.507 255389 8 9 504050504050 0.460 0.417 231751 210300 10 1594050 0.379 603512 1/(1+10.2%)^n FCF*Discount rate Sum of all PVs 11 775200 0.344 266328

d). NPV at 8.25 million p.a. of sales = -3,634,106

NPV at 12.15 million p.a. of sales = 214,081

Note: The base case valuation tables above have been used for calculating these NPVs by changing the sales figure. Tables for each scenario is not posted due to the answer word limit constraint.

e). Using Solver, for NPV = 0, break-even level of sales = 11,933,037

f). Additional sales required p.a. = 3,601,504 (Using Solver and the same valuation table template as above)

4 11 Additional sales calculation: Formula Sales disruption in Year 0 74%S 3601504 Time (n) Sales revenue (S) COGS SG&A Depreciation (D) EBIT Tax @ 35% Unlevered net income (N 0 1 8 10 -5040000 10200000 10200000 13801504 13801504 13801504 13801504 13801504 13801504 1380150413801504 37296001 -7548000 -7548000 -10213113 -10213113 -10213113 -10213113 -10213113 -10213113-10213113 -10213113 0 -2030000] -2030000 -2030000 -2030000 -2030000 -2030000 -2030000 -2030000] -2030000] -2030000 0 -391000 -391000 -391000 - 391000 -391000 -391000 -391000 -391000 - 391000 - 391000 -1310400 231000 231000 1167391.2 1167391.2 1167391.2 1167391.2 1167391.2 1167391.2 1167391.2 1167391.2 458640 -80850 -80850 -408586.9 -408586.9 -408586.9 -408586.9 -408586.9 -408586.9 -408586.9 -408586.9 -851760 150150 150150 758804.25 758804.25 758804.25 758804.25 758804.25 758804.25 758804.25 758804.25 Cost of machine/10 S-COGS-SG&A-D 35% EBIT EBIT-Tax 15%*S 10%"COGS I+R-P NWCn-1-NWCn Inventory (1) Receivables ("R) Payables (P) NWC Increase in NWC 1090000 -756000 372960 706960] -706960 1090000 1090000 1090000 1090000 1090000 1090000 1090000 1090000 1090000 1530000 1530000 2070225.7 2070225.7 2070225.7 2070225.7 2070225.7 2070225.7 2070225.7 2070225.7 -754800] -754800] -1021311] -1021311] -1021311| -10213111 -1021311| -1021311| -1021311| -1021311| 18652001 1865200 2138914.3 2138914.3 2138914.3 2138914.3 2138914.3 2138914.3 2138914.3 1048914.3 -1158240 0 -273714.3 0 0 0 0 0 0 1090000 pool 1048914.3 150150 391000 150150 758804.25 758804.25 758804.25 758804.25 758804.25 758804.25 758804.25 758804.25 391000 391000 391000391000 391000 391000 391000 391000 391000 Unlevered net income (N Depreciation (D) Capital expenditure (CE) Change in NWC Free Cash Flow (FCF) -851760 0 -3910000 -706960 -5468720 -1158240 -617090 0 -273714.3 0 0 1090000 1048914.3 541150 876089.91 1149804.2 1149804.2 1149804.2 1149804.2 1149804.2 1149804.2 2239804.2 1048914.3 NI+D-CE-Change in NWC 1/(1+10.2%) n FCF*Discount rate Sum of all PVS Free Cash Flow (FCF) Discount rate @ 10.2% PV of FCF NPV -5468720 1.000 -5468720 -617090 0.907 -559973 541150 876089.91 1149804.2 1149804.2 1149804.2) 1149804.2) 1149804.2 1149804.2 2239804.2| 1048914.3 0.823 0.747 0.678 0.615 0.558 0.507 0 .460 0.417 0.379 0.344 445610 654642779646 707483641999 582576 528654 479722 847997360365