Worldwide Paper

Topics: Net present value, Weighted average cost of capital, Internal rate of return Pages: 7 (1938 words) Published: February 15, 2015

Drexel University
Worldwide Paper Company
Group 2 Case Analysis
Brian Burke, John Lafferty

FIN 790 Winter 2015
Seminar in Finance
Dr. Samuel H. Szewczyk
Lebow School of Business
February 9, 2015

Executive Summary:

Blue Ridge Mill is a wood mill owned by Worldwide Paper Company and supplies wood pulp for the company for use in paper production. Blue Ridge Mill bought its wood supply from Shenandoah Mill’s excess production of shortwood that was processed from its longwood supplies. In 2006, Bob Prescott, the controller for Blue Ridge Mill, was considering a project that would give Blue Ridge Mill the capability to process longwood into shortwood, which would eliminate the need to purchase from Shenandoah Mill, as well as compete with Shenandoah Mill in the shortwood market.

Project Overview:

The project would provide Blue Ridge Mill with a new longwood yard, giving the mill the ability to produce shortwood, a required input for paper production, from longwood. The project would also product excess shortwood that would allow Blue Ridge Mill to sell shortwood as an additional revenue source, competing with their current shortwood supplier. Construction for project would begin in 2007 and production would begin in 2008. The project will cost $18 million, with $16 million in 2007 and an additional $2 million in 2008. The $18 million investment will be depreciated using the straight-line method for six years and a zero salvage value. Although, the equipment is believed to be able to be sold at the end of the project for $1.8 million.

The main purpose of the project is to save on operational costs by producing shortwood. The cost savings is estimated to be $2 million in the first year and $3.5 million in the following five years. In addition, the longwood yard would provide enough capacity to allow Blue Ridge Mill to sell shortwood on the market. Bob Prescott confidently estimates that shortwood sales in 2008 will be $4 million, and will increase to $10 million in the remaining five years. There are also expenses from the new shortwood sales as well as tax expenses. Cost of goods sold (COGS) is estimated to be 75% of the new shortwood revenue. In addition, Sales, General and Administration (SG&A) expenses are estimated at 5% of the additional revenue. Blue Ridge Mill will also need to invest working capital as sales increase. The additional working capital required is estimated at 10% of the change in revenues from the previous year. However, the investment in working capital is fully recovered at the end of the project. Finally, the income tax rate for the company is 40% of earnings. Table 1 below shows all of the incremental cash flows as a result of this project.

Table 1: Longwood Yard Project Free Cash Flows
Discount Rate:

The internal rate of return (IRR) from the free cash flows of the project based on the estimates given by Bob Prescott is 11.30%, which is lower than the company’s published hurdle rate of 15%. However, that hurdle rate was calculated 10 years ago when the 30 year Treasury Bond was around 10%, more than double current interest rates (see table 2 below). Therefore, it is recommended that a weighted average return rate (WACC) be calculated and used as that hurdle rate. In order to calculate the WACC, the cost of debt and the cost of equity must be calculated first based on the information provided by the case. The interest rates and market risk premium are found in Table 2, and the company’s balance data, bond rating, Beta, and tax rate are found in Table 3. It is assumed that the debt and equity listed in Table 3 represents all of the debt and equity for the company.

The cost of debt is the weighted average cost of each debt held by the company. Table shows two debts to include: a bank loan payable at 6.38% (LIBOR + 1%) and Long Term debt. LIBOR is a floating interest rate that changes daily. However, since the bank loan is only a small...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • CP Paper case
  • Paper Mache
  • School Papers
  • Enzymes and Paper
  • Reflective Paper
  • Paper Cheater
  • Maths C1 Papers
  • How to Make Reaction Paper

Become a StudyMode Member

Sign Up - It's Free