The investment proposed by Bob Prescott, an on-site longwood woodyard, would reduce operating costs by processing tree-length logs, as well as increase revenues by selling shortwood.
In 2006, Worldwide Paper’s Blue Ridge Mill had to purchase shortwood from competitor, Shenandoah Mill. The new woodyard would begin operations in 2008, thus saving Blue Ridge Mill $2mm in year one and $3.5mm the years after. The savings would come from the difference in the cost of producing shortwood on-site versus purchasing it on the open market.
Revenues would be generated by taking advantage of the excess production capacity by selling shortwood on the open market as soon as possible. Blue Ridge Mill would show expected revenues of $4mm in 2008 and $10mm from 2009 – 2013. On paper this project seemed like a can’t miss investment.
What are the yearly cash flows that are relevant for this investment decision? Do not forget the effect of taxes and the initial investment amount. Itemize the cash flows for each of the six years of the investment.
There are several cash flows in this project that need to be included in the discounted cash flow analysis: Capital Spending – Though the capital spending for the project will be $18M, only $16M of it will be spent in 2007; the remainder will be spent in 2008. Thus, the initial cash flow for this project is $16M for Year 0, 2007 and $2M in 2008. Depreciation – the Longwood yard will not be operational until 2008; thus, depreciation will be begin in 2008 and continue for 6 years on a straight line basis of $3M per year. After Tax Salvage – 10%, or $1.8M pre-tax, of the initial investment is expected to be recovered at the end of the project. Since the book value of the investment is 0, the after tax salvage value can be calculated as $1.8M-$0.72M = $1.08M....