Fundamentals of Capital Budgeting: Billingham Packaging Production Capacity

Fundamentals of Capital Budgeting: Billingham Packaging Production Capacity

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 partially disrupt production. The firm has just completed a $50,000 feasibility study to analyze the decision to buy the XC-750, resulting in the following estimates:

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 expected to be 70% of their sale price. The increased production will require additional inventory on hand of $1 million to be added in year 0 and depleted in year 10.

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 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%, compute the NPV of the


d. While the expected new sales will be $10 million per year from the expansion, estimates range from $8 million to $12 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 break-even 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 $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. What level of additional sales (above the $10 million expected for the XC-750) per year in those years would justify purchasing the larger machine?


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Fundamentals of Capital Budgeting: Percolated Fiber Free Cash Flow

Fundamentals of Capital Budgeting: Percolated Fiber Free Cash Flow in $1.50 only (Instant Download)

You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant’s report on your desk, and complains, “We owe these consultants $1 million for this report, and I am not sure their analysis makes sense. Before we spend the $25 million on new equipment needed for this project, look it over and give me your opinion.” You open the report and find the following estimates (in millions of dollars):

All of the estimates in the report seem correct. You note that the consultants used straight-line depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended. The report concludes that because the project will increase earnings by $4.875 million per year for ten years, the project is worth $48.75 million. You think back to your halcyon days in finance class and realize there is more work to be done!

Bauer Industries Free Cashflow Projections

NPV vs discount rate comparison for two mutual...

Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12 to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars):

a. For this base-case scenario, what is the NPV of the plant to manufacture lightweight trucks?