Question

Yoder Technologies is considering expanding its production capacity by purchasing a new machine, the TB-2000. The cost of the TB-2000 is $3 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 TB-2000, resulting in the following estimates: • Marketing: Once the TB-2000 is operating next year, the extra capacity is expected to allow for $12 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 $4 million this year. The cost of goods for the products produced by the TB-2000 is expected to be 75% of their sale price, the same as with existing equipment. The increased production will require additional inventory on hand of $2 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 $1.5 million per year. Accounting: The TB-2000 will be depreciated via the straight-line method over the 10-year life of the machine. The firm expects receivables from the sales to be 10 percent of revenues and payables to be 15 percent of the cost of goods sold. Billingham's marginal corporate tax rate is 40 percent. For simplicity, assume that any changes in payables and receivables begin in year 1 and are closed out at the end of year 10. If the appropriate cost of capital for the expansion is 15 percent, calculate the incremental free cash flows associated with installing the TB-2000 and compute the NPV and IRR of the project. Should Yoder Technologies purchase this new machine?