6. Will Paramount Paper have to raise external capital over the next 12 months? If so how much? If not, why not? 7. Is Warren correct in saying "there is more to us than meets the eye"? Explain. 8. If you are Warren, explain how you would attempt to convince the rating agencies that the firm's debt rating should be raised. "Greg, the board of directors' meeting is scheduled two weeks from today, and I'm depending on you to come up with a realistic and honest appraisal of our company's position," said Warren, to his assistant Greg Chapman. "I'm sure that there's more to us than meets the eyel" he quipped. "But those dam analysts are still punishing us for Robert's accounting jugglery," he said with a frown. "Why don't you prepare a detailed financial performance analysis of the firm for the most recent three years, complete with industry comparisons and a DuPont analysis? It will help me make the case to the rating agencies that they need to raise our rating. "After that, I'd like you to prepare a 12-month pro-forma forecast using a scenario analysis. Use our current average compound growth rate in sales as the base estimate and vary that up and down by 10% for the best-case and worst-case scenarios respectively. This will help us figure out how much additional funds we are going to have to acquire over the next year. The production folks tell me that we are currently operating at 90% of capacity, so we should be able to support some growth without additional plant and equipment," he added looking rather stressed. Warren Badges, the new CFO of Paramount Paper Inc., was hired last year to replace Robert Malnight. Robert was fired because the firm had come under Federal investigation for noncompliance of the Sarbanes-Oxley Act (2002). Under Robert's watch, the stock had plummeted to its all-time low despite reasonably strong sales and income growth. Warren implemented various measures to bring the firm in compliance with the 2002 Act. The firm's sales had been increasing steadily due to its excellent commitment to quality. However, stock market analysts had been unforgiving because the stock price was still hovering around its all-time low of $12. The significant growth rate that the firm had been experiencing had necessitated the infusion of more capital. But lenders were reluctant to lower interest rates due to their suspicions about the firm's past reporting practices. Warren had a hunch that the company could save a bundle in interest costs if the markets were convinced that the firm's accounting and reporting practices were clearly within the Sarbanes-Oxley guidelines. He knew that an upgrade in the firm's credit rating would help expedite the process. Moreover, when he took over from Robert, Warren realized that there was no formal policy of conducting long-term planning and forecasting in place. Most of what Robert did was based on his gut feelings regarding the economy. Being an industry veteran, Warren was fully aware that haphazard growth could be a recipe for disaster. He was determined to set things straight and he knew that the market would take note. One of the first things that Warren did upon joining paramount was to lure his assistant, Greg Chapman, away from their prior employer, Holland Paper. Greg had been working for Holland Paper for over 10 years. When the opportunity came up, Greg initially hesitated. He was enjoying a fairly comfortable lifestyle, and the city had a lot to offer. But Warren made him an offer that he found very hard to refuse. The remuneration package included a very attractive stock option plan and a signing bonus. Moreover, Greg knew that Warren was an honest, ethical person and he enjoyed working for him. Paramount Paper Inc. Prior 3-Year Income Statements 2013 2014 2015 D 1 -2 13 14 15 16 17 18 19 Sales Revenues Cash Operating Costs Depreciation Total Operating costs Operating Income (EBIT) Interest Expenses Taxable Income Taxes Net Income Preferred Dividends Addition to Retained Earnings 28,255,000 22,321,450 2,775,000 25,096,450 3,158,550 325,000 2,833,550 1,133,420 1,700,130 108,500 1,591,630 37,340,000 32,112,400 2,915,000 35,027,400 2,312,600 512,000 1,800,600 720, 240 1,080,360 136,500 943,860 54,670,000 47,562,900 3,513,000 51,075,900 3,594,100 623,000 2,971,100 1,188,440 1,782,660 171,500 1,611,160 Paramount Paper Inc. Prior 3-Year Balance Sheets 2013 2014 2015 Cash Marketable Securities Accounts Receivables Inventories Current Assets Net Fixed Assets Total Assets 396,000 460,000 2,225,000 3,850,000 6,931,000 13,875,000 20,806,000 428,000 540,000 2,525,000 4,950,000 8,443,000 14,576,000 23,019,000 587,000 638,000 3,758,000 6,013,000 10,996,000 17,568,000 28,564,000 Accounts Payables Accruals Notes Payables Current Liabilities Long Term Debt Total Liabilities Preferred Stock Common Stock Retained Earnings Total Owner's Equity Total Liabilities and Owner's Equity 425,000 495,000 150,000 1,070,000 5,250,000 6,320,000 1,550,000 10,250,000 2,686,000 14,486,000 20,806,000 478,000 567,000 180,000 1,225,000 6,714,140 7,939,140 1,950,000 9,500,000 3,629,860 15,079,860 23,019,000 518,000 694,000 175,000 1,387,000 8,985,980 10,372,980 2,450,000 10,500,000 5,241,020 18,191,020 28,564,000 1 2 3 4 25 26 2 3 Aggregate Income Statement for Paper Industry - Select 6 for Year Ended December 31, 2015 4 5 6 7 8 9 10 11 Sales Revenues Cash Operating costs Depreciation Total Operating Costs Operating Income (EBIT) Interest Expenses Taxable income Taxes Net Income Preferred Dividends Addition to Retained Earning 590,000,000 505,040,000 31,270,000 536,310,000 53,690,000 7,670,000 46,020,000 18,408,000 27,612,000 590,000 27,022,000 12 13 14 15 16 17 2 3 4 Aggregate Balance Sheet for Paper Industry- Select 6 As of December 31, 2015 von 8 9 Cash Marketable Securities Accounts Receivables Inventories Current Assets Net Fixed Assets Total Assets 6,554,000 45,200 32,046,800 55,867,200 94,513,200 131,486,800 226,000,000 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Accounts Payables Accruals Notes Payables Current Liabilities Long Term Debt Total Liabilities Preferred Stock Common Stock Retained Earnings Total Owner's Equity Total Liabilities and Owner's Equity 5,085,000 3,073,600 1,898,400 10,057,000 72,885,000 82,942,000 11,752,000 30,510,000 100,796,000 143,058,000 226,000,000 36 2 3 Historical Sales for Paramount Paper Inc. 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Revenues 8,825,000 12,450,000 13,246,000 14,250,000 16,275,000 18,235,000 21,234,000 24,345,000 28,255,000 37,340,000 54,670,000 10