# Worldwide Paper Company

**Topics:**Net present value, Cash flow, Discounted cash flow

**Pages:**6 (773 words)

**Published:**April 21, 2014

EPPM3644 KEWANGAN KORPORAT DAN PENSTRUKTURAN

SET: 3

REPORT OF CASE STUDY:

CASE 19 WORLDWIDE PAPER COMPANY

PROFESSOR:

DR. LIZA MARWATI BINTI MOHD YUSOFF

GROUP MEMBERS:

LOH CHAI LINGA140178

GOH HOOI SANA139708

KERK (KEH) YIH JENA139574

SEMESTER 2, 2013/2014

INTRODUCTION

In December 2006, Bob Prescott, the controller for the Blue Ridge Mill, was considering the addition of a new on-site longwood woodyard. Two primary benefits for this new addition include eliminating the need to purchase shortwood from an outside supplier and creating an opportunity to sell shortwood on the open market. Also, the new woodward would reduce operating costs and increase revenues. Blue Ridge Mill currently purchased shortwood from the Shenandoah Mill, which is a direct competitor. Thus, adding the new longwood equipment would mean that the Prescott would no longer need to use the Shenandoah Mill as a shortwood supplier and that the Blue Ridge Mill would instead compete with the Shenandoah Mill by selling on the shortwood market. The question for Prescott was whether these expected benefits were enough to justify the $18 million capital outlay plus the incremental investment in working capital over the six-year life of the investment.

SYMPTOMS

The addition of a new on-site longwood woodyard would bring benefit to Blue Ridge Mill in term of decreasing their operating cost and also increasing their revenue or sales. But the estimation of revenue and cost did by Prescott do not reflect the inflation rate. Thus, this project’s evaluation will be less accurate.

PROBLEMS

By adding the new on-site longwood woodyard, Prescott estimates that the revenue for their company would increase to $4 million in year 2008 and goes to $8 million every year until year 2013. And also the cost of goods sold would be 75% of revenue and SG&A would be 5% of revenue. But all of this estimation does not include the inflation. So, we are using the net present value (NPV) and internal rate of return (IRR) to evaluate this longwood woodyard project which these methods involve the discounted cash flow.

PROBLEM SOLVINGS

First, we need to find the required rate of return (WACC) to calculate the discounted cash inflow so that we can evaluate the longwood woodyard project more accurately. Calculate KE : Cost of Equity (CAMP)

KE = KRF + (KM – KRF) Beta

Beta = 1.1

KRF= 4.60% : Government bonds 10-year,

Risk premium = 6.0%

KE = 4.6% + (6.0%) 1.1

= 11.2%

Calculate KD: Cost of Debt

KD = Bank Loan Payable + Long Term Debt

= $ 500 + $ 2500

= $ 3000

KD = (500/3000) * (5.38% + 1%) + (2500/3000) * (5.78%)

= 5.88%

KD (1-Tax)

=5.88% (1-40%)

= 3.528%

Calculate capital structure: WE and WD

Equity = Current Market Share Price x Shares Outstanding

= $24 x 500m

= $12000m

Debt = Bank Loan Payable + Long Term Debt

= RM 500 + RM 2500

= RM 3000

E+D = $ 12000 + $ 3000

= $ 15000

WE = 12000/15000

= 0.8/80%

WD = 3000/15000

= 0.2/20%

Calculate WACC

WACC = WE. KE + WD .KD (1-T)

= 0.8 (11.2%) + 0.2 (3.528%)

= 9.6656 @ 9.67%

So. The WACC (required rate of return) is 9.67%

Second, we need to find the cash inflow of this project.

2007

2008

2009

2010

2011

2012

2013

$'million

$'million

$'million

$'million

$'million

$'million

$'million

Revenue

4

10

10

10

10

10

(-) COGS (75% of reveue)

3

7.5

7.5

7.5

7.5

7.5

(-) SG & A (5% of revenue)

0.2

0.5

0.5

0.5

0.5

0.5

Net Shortwood Income

0.8

2

2

2

2

2

Operating Saving

2

3.5

3.5

3.5

3.5

3.5

(-) Depreciation ($18million/6 years)

3

3

3

3

3

3

Earning Before Interest & Tax

-0.2

2.5

2.5

2.5

2.5

2.5

(-) Tax (40%)

-0.08

1

1

1

1

1

Earning After Tax

-0.12

1.5

1.5

1.5

1.5

1.5

Add Back Depreciation

3

3

3

3

3

3

Free Cash Flow...

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