Table of Content

Background

• Selling paper products; production of supply

• In December 2006, Bob Prescott, the controller for the Blue Ridge Mill, considered the addition of a new on-site longwood woodyard.

• Blue Ridge Mill currently purchases its shortwood from the Shenandoah Mill

Data Analysis

The new woodyard will begin operating in 2008

Total cost = $18 million dollars

• $16 million paid in 2007

• $2 million paid in 2008

Operating savings: estimated to be $19.5 million throughout the equipment’s lifetime.

• $2 million for 2008

• $3.5 million per year

Expected revenue:

• $4 million for 2008

• reach $10 million in 2009

• remain steady at the $10 million level through 2013

Costs of goods sold:

• 75% of revenues

SG&A expenses

• 5% of revenues

Net working capital:

• 10% of annual revenues

• Recovered:

• $400,000 worth of net working capital in 2008

• $1.8 million (before taxes) from the capital investment

Case Question

Q: Should the Worldwide Paper Company take the project?

Would the expected benefits be enough to justify capital outlay plus the incremental

investment in working capital over the six-year lifetime of the investment??

Weight of Debt and EquityWhat is the weight of total debt and total equity?

Weight of Equity

= 12,000/15,000 = 80%

Weight of Debt

3,000/15,000 = 20%

Total Capital

Total Debt + Total Equity 12,000 +3,000 = 15.000 Billion

Total Debt

Long-Term Debt + Bank Loan Payable 2,500 + 500 = 3.000(Billion)

Total Equity

Shares Outstanding * Market Value Per Share 500(million)*24 = 12.000 Billion

Cost of Debt and Cost of Equity

• Prescott used an outdated figure to calculate the discount rate

Treasury yield was adjusted to represent current interest rates

Cost of Debt and Cost of

Equity

• Rf + Beta (Risk Premium) = 4.6% + 1.1 (6%) = 11.20%CAPM

• (loan/total debt)(bank loan rate +1%) + (long-term notes/total debt)(“A” Corporate bond yield)

• (500/3000)*(5.38+1)+(2500/3000)*(5.78)= 5.88%

Weighted Cost of Debt

WACC

(Wd)(Rd)(1-Tax)+(We)(Re)

= (20%)(5.88%)(1-0.4) + (80%)(11.20%)

= 9.6656%

VALUATION OF WORLDWIDE PAPER COMPANY

Using project WACC of 9.665%

• NPV of Free Cash Flow

• $16,750,815

• NPV>0

• $750,815

Using firm hurdle rate of 15%

• NPV of Free Cash Flow

• $13,910,510

• NPV>0

• $(2,089,490)

(10,000,000)

(8,000,000)

(6,000,000)

(4,000,000)

(2,000,000)

-

2,000,000

4,000,000

6,000,000

8,000,000

0% 5% 10% 15% 20% 25% 30% 35%

Net

Pre

sen

t V

alu

e

Discount Rate

IRR = 11%

Conclusion

•Calculation for NPV is $750,815

•IRR is greater than the project WACC

•If the other conditions are likely unchanged

Yes, the longwood woodyard investment

should be approved

Gr

ou

p M

em

be

rs

Dung Le

Connie Chen

Guanhong Lin

Niclas Gamaleya