BWP intends to purchase a machine that will result in a major improvement in product quality

| June 6, 2016

Question
BWP intends to purchase a machine that will result in a major improvement in product quality along with a small increase in manufacturing efficiency. The machine will cost $1 million, which will be borrowed at 9%. The quality improvement is expected to have a significant impact on BWP’s competitive position. Indeed, management expects sales to increase by 5% in spite of a planned 10% price increase. The efficiency improvement combined with the price increase will result in variable costs of 36% of revenue. Fixed cost, however, will rise by 19%.

a. Compute BWP’s, new contribution, contribution margin, EAT, DOL and EPS if it purchases the new machine.

b. If all of BWP’s projections come to pass, how will stock price be influenced? What factors should be considered in estimating a stock price change?

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