NTERNATIONAL PAPER: A RECURRING DILEMMA International Paper Company is the largest forest products company in the world. It operates in five segments of the forest products industry:

1. Printing paper. Uncoated and coated papers used for reprographics and printing, envelopes, writing tablets, file folders, and magazines.

2. Packaging. Liner board used for corrugated boxes and bleached packaging board used for food, pharmaceutical, cosmetic, and other consumer products.

3. Distribution. Sale of printing, graphics, packaging, and similar products through wholesale and retail outlets. Sales of these outlets comprise approximately 20 percent of International Papers products and 80 percent of other manufacturers products.

4. Specialty products. Film, door facings, wood siding, fabrics, and chemicals used for adhesives and paints.

5. Forest products. Logs, lumber, plywood, and wood panels. International Paper has the largest timber holdings of any private-sector entity in the United States.

Exhibit 6.31 presents product segment data for International Paper for Year 7 through Year 10. The proportion of sales generated from within the United States decreased from 79 percent in Year 7 to 71 percent in Year 10. The proportion generated from within Europe fluctuated between 17 and 19 percent during the four-year period. The proportion from the rest of the world, primarily East Asia, increased from 3 percent in Year 7 to 12 percent in Year 10.

The financial statements for International Paper for Year 7 through Year 10 appear in Exhibit 6.32 (income statement), Exhibit 6.33 (balance sheet), and Exhibit 6.34 (statement of cash flows). Exhibit 6.35 presents financial ratios for International Paper based on the reported amounts.

The notes to the financial statements reveal the following information:

1. Change in accounting principle. Effective January 1, Year 8, International Paper changed its method of accounting for start-up costs on major projects to expensing these costs as incurred. Prior to Year 8, the firm capitalized these costs as part of property, plant, and equipment and amortized them over a five-year period. The firm made the change to increase the focus on controlling costs associated with facility start -ups. International Paper recorded a pretax charge of $125 million ($75 million after taxes) as the cumulative effect of an accounting change in Year 8.

2. Gain on sale of partnership interest. On March 29, Year 10, International Paper sold its general partnership interest in a partnership that owned 300,000 acres of forestlands located in Oregon and Washington. Included in the partnership were forestlands, roads, and $750 million of long-term debt. As a result of this transaction, International Paper recognized a pretax gain of $592 million ($336 million after taxes). International Paper maintains general partnership interests in several partnerships created by the firm as a means of raising capital from outside investors. International Paper consolidates the financial statements of these partnerships with its own financial statements and shows the interest of the remaining partners (limited partners) as a minority interest.

3. Restructuring and asset impairment charges. During the first quarter of Year 10, the firms board of directors authorized a series of management actions to restructure and strengthen existing businesses that resulted in a pretax charge of $515 million ($362 million after taxes). The charge included $305 million for the write-off of certain assets, $100 million for asset impairments, $80 million in associated severance costs, and $30 million in other expenses, including the cancellation of leases.

During the fourth quarter of Year 10, International Paper recorded a $165 million pretax charge ($105 million after taxes) for the write-down of its investments in a company that markets digital communications products and to record its share of a restructuring charge announced by that investee.

These restructuring charges were the first recognized by International Paper since Year 6. In November, Year 6, the firm recorded a pretax charge of $398 million ($263 million after taxes) to establish a productivity improvement reserve. More than 80 percent of this charge represented asset write-downs for facility closings or realignments and related severance and relocation costs. The balance covers one-time costs of environmental cleanup, remediation, and legal costs. In December, Year 5, the firm recorded a $60 million ($37 million after taxes) reduction in workforce charge to cover severance costs associated with the elimination of more than 1,000 positions from its worldwide workforce. In December, Year 4, International Paper completed a review of operations in the context of its ongoing programs to emphasize value-added products in growing markets and improve the efficiency of its facilities. As a result, the firm recorded a pretax charge of $212 million ($13 7 million after taxes), principally related to the planned sale or closure of certain wood products and converting facilities, the estimated costs of environmental remediation, and severance and other personnel expenses associated with the business improvement program.

On July 9, Year 11, International Paper announced a plan to restructure or eliminate certain production operations and cut 9,000 jobs, more than 10 percent of its workforce. It recognized a restructuring charge of $385 million pretax. It also recognized a $93 million charge related to pending litigation.

Required

a. For each of the three categories of income items described earlier for Year 7 through Year 10, discuss (l) whether you would eliminate it when using earnings to forecast the future profitability of International Paper and, if so, (2) the adjustments you would make to the income statement, balance sheet, and statement of cash flows.

b. Taking into consideration the adjustments from part a, analyze and interpret the changes in the profitability and risk of International Paper during this four-year period. The statutory tax rate is 35 percent in each year.

Question to be answered:

Taking into consideration the adjustments from part a, analyze and interpret the changes in the profitability and risk of International Paper during this four-year period. Year 5 and Year 6 were years of ecoomic recession in the United States. The statutory tax rate is 34 percent in year 4 to year 6 and 35 percent in year 7

How does that impact your qualitative analysis of the changes in the profitability. It also says to look at the risk ratios and assess those changes. Do this as 3 parts. Profitability , ST risk, Long Term Solvency.

EXHIBIT 6.32 \begin{tabular}{|c|c|c|c|c|} \hline \multicolumn{5}{|c|}{\begin{tabular}{l} International Paper \\ Income Statement \\ (amounts in millions) \\ (Case 6.3) \end{tabular}} \\ \hline & \multicolumn{4}{|c|}{ Year Ended December 31: } \\ \hline & Year 10 & Year 9 & Year 8 & Year 7 \\ \hline & $20,143 & $19,797 & $14,966 & $13,685 \\ \hline Gain on Sale of Partnership Interest............ & 592 & - & - & - \\ \hline & (16,095) & (14,927) & (11,977) & (11,051) \\ \hline \begin{tabular}{l} Selling and Administrative Expenses ............. \\ Restructuring and Asset \end{tabular} & (2,628) & (2,349) & (1,925) & (1,786) \\ \hline Interest Expense... & (530) & (493) & (349) & (310) \\ \hline & (330) & (719) & (236) & (213) \\ \hline & (169) & (156) & (47) & (36) \\ \hline & $303 & $1,153 & 432 & $289 \\ \hline & - & + & (75) & - \\ \hline Net Income.. & & 1.153 & $357 & $289 \\ \hline \end{tabular} EXHIBIT 6.31 International Paper Product Line Segment Profitability Analysis (Case 6.3) \begin{tabular}{|c|c|c|c|c|} \hline & Year 10 & Year 9 & Year 8 & Year 7 \\ \hline \multicolumn{5}{|l|}{ Sales Mix } \\ \hline Printing Papers. & 26% & 29% & 28% & 27% \\ \hline & 23 & 21 & 22 & 22 \\ \hline & 22 & 24 & 22 & 22 \\ \hline & 16 & 16 & 17 & 17 \\ \hline & 13 & 10 & 11 & 12 \\ \hline & 100% & 100% & 100% & 10% \\ \hline \multicolumn{5}{|l|}{ Rate of Return on Assets } \\ \hline Printing Papers .+ & 2.1% & 15.3% & .3% & (1.9%) \\ \hline Packaging. & 6.9 & 17.9 & 9.5 & 6.2 \\ \hline & 8.1 & 7.3 & 6.1 & 5.3 \\ \hline Specialty Products. & (1.4) & 5.7 & 9.6 & 10.1 \\ \hline & 17.2% & 8.7% & 27,3% & 30.4% \\ \hline \multicolumn{5}{|l|}{ Profit Margin } \\ \hline Printing Papers .+ & 3.3% & 17.7% & .5% & (3.1%) \\ \hline & 8.5 & 16.8 & 8.7 & 6.1 \\ \hline & 2.3 & 2.1 & 2.1 & 1.8 \\ \hline & (1.5) & 6.3 & 10.3 & 10.7 \\ \hline Forest Products, & 34.7% & 18.5% & 24.4% & 28.7% \\ \hline \multicolumn{5}{|l|}{ Assets Turnover } \\ \hline & .65 & .87 & .66 & .60 \\ \hline & .81 & 1.07 & 1.09 & 1.03 \\ \hline & 3.47 & 3.46 & 2.86 & 2.89 \\ \hline & .96 & .91 & .93 & .94 \\ \hline & .50 & .47 & 1.12 & 1,06 \\ \hline \end{tabular} EXHIBIT 6.34 International Paper Statement of Cash Flows (amounts in millions) (Case 6.3) \begin{tabular}{|c|c|c|c|c|} \hline \multirow{3}{*}{ Operations } & \multicolumn{4}{|c|}{ Year Ended December 31: } \\ \hline & \multirow[t]{2}{*}{ Year 10} & \multirow[t]{2}{*}{ Year 9} & Year 8 & Year 7 \\ \hline & & & & \\ \hline & $303 & $1,153 & $357 & $289 \\ \hline & 1,194 & 1,031 & 885 & 898 \\ \hline Restructuring and Asset lmpairment Charges ..... & 680 & - & - & - \\ \hline Changes in Accounting Principles ................. & - & - & 75 & \\ \hline & (592) & - & - & - \\ \hline Other Addbacks and Subtractions ................... & 240 & 54 & 8 & 32 \\ \hline & $1,825 & $2,238 & $1,325 & $1,219 \\ \hline (Increase) Decrease in Accounts Receivable ......... & 192 & 45 & (339) & 78 \\ \hline (Increase) Decrease in Inventories ................. & 174 & (320) & 8 & (93) \\ \hline & (47) & 38 & (35) & 63 \\ \hline Increase (Decrease) in Accounts Payable ............ & (38) & 260 & 115 & (170) \\ \hline Increase (Decrease) in Other Current & & & & \\ \hline Liabilities ............................. & (367) & (13) & 169 & (168) \\ \hline Cash Flow from Operations.. & $1,739 & $2,248 & $1,243 & $929 \\ \hline \multicolumn{5}{|l|}{ Investing } \\ \hline & $(t,394) & $(1,518) & $(1,114) & $(971) \\ \hline & (1,586) & (I,038) & (396) & (151) \\ \hline Cash Flow from Investing... & $(2,980) & $(2,556) & $(1,510) & $(1,122) \\ \hline \multicolumn{5}{|l|}{ Financing } \\ \hline & $ & 57 & s- & $ \\ \hline Decrease in Short-Term Borrowing ................ & (23) & - & (115) & - \\ \hline & 1,909 & 1,505 & 1,059 & 1,276 \\ \hline & (375) & (950) & (275) & (1,016) \\ \hline & 100 & 66 & 67 & 225 \\ \hline & (291) & (237) & (210) & (208) \\ \hline & (39) & (91) & (231) & (67) \\ \hline Cash Flow from Financing.. & $1,281 & & $295 & \\ \hline & 540 & $42 & $28 & $17 \\ \hline & 312 & 270 & 242 & 225 \\ \hline & $352 & 5312 & $270 & $242 \\ \hline \end{tabular} EXHIBIT 6.35 International Paper Financial Statement Ratios (Case 6.3) \begin{tabular}{|c|c|c|c|c|} \hline . & Year 10 & Year 9 & Year 8 & Year 7 \\ \hline & 4.1% & 8.2% & 4.2% & 3.8% \\ \hline & .8 & .9 & .9 & .8 \\ \hline & 3.1% & 7.8% & 3.7% & 3.2% \\ \hline & 1.5% & 5.8% & 2.4% & 2.1% \\ \hline & 3.0 & 2.9 & 2.9 & 2.7 \\ \hline Rate of Return on Common Shareholders' Equity .......... & 3.5% & 16.1% & 5.6% & 4.7% \\ \hline \multicolumn{5}{|l|}{ Equity } \\ \hline & 79.9% & 75.4% & 80.0% & 80.8% \\ \hline & 13.0% & 11.9% & 12.9% & 13.1% \\ \hline & 2.6% & 2.5% & 2.3% & 2.3% \\ \hline & 1.7% & 3.6% & 1.6% & 1.5% \\ \hline & 7.9 & 8.2 & 7.3 & 7.4 \\ \hline & 5.7 & 6.1 & 5.8 & 5.6 \\ \hline & 1.3 & 1.7 & 1.5 & 1.4 \\ \hline & 1.0 & 1.2 & 1.2 & 1.1 \\ \hline & .5 & .6 & .6 & .5 \\ \hline Cash Flow from Operations/Average ....................... & 32.3% & 50.5% & 30.9% & 21.8% \\ \hline \multicolumn{5}{|l|}{ Current Liabilities } \\ \hline & 46 & 44 & 50 & 50 \\ \hline & 64 & 59 & 62 & 65 \\ \hline & 33 & 31 & 35 & 38 \\ \hline & 60.3% & 59.3% & 61.6% & 62.6% \\ \hline & 76.4% & 82.0% & 68.5% & 57.8% \\ \hline & 9.9% & 16.3% & 11,4% & 9.0% \\ \hline \multicolumn{5}{|l|}{ Total Liabilities } \\ \hline & 2.5 & 5.1 & 3.1 & 2.7 \\ \hline Cash Flow from Operations/Capital Expenditures ......... & 1.3 & 1.5 & 1.1 & 1.0 \\ \hline \end{tabular} EXHIBIT 6.32 \begin{tabular}{|c|c|c|c|c|} \hline \multicolumn{5}{|c|}{\begin{tabular}{l} International Paper \\ Income Statement \\ (amounts in millions) \\ (Case 6.3) \end{tabular}} \\ \hline & \multicolumn{4}{|c|}{ Year Ended December 31: } \\ \hline & Year 10 & Year 9 & Year 8 & Year 7 \\ \hline & $20,143 & $19,797 & $14,966 & $13,685 \\ \hline Gain on Sale of Partnership Interest............ & 592 & - & - & - \\ \hline & (16,095) & (14,927) & (11,977) & (11,051) \\ \hline \begin{tabular}{l} Selling and Administrative Expenses ............. \\ Restructuring and Asset \end{tabular} & (2,628) & (2,349) & (1,925) & (1,786) \\ \hline Interest Expense... & (530) & (493) & (349) & (310) \\ \hline & (330) & (719) & (236) & (213) \\ \hline & (169) & (156) & (47) & (36) \\ \hline & $303 & $1,153 & 432 & $289 \\ \hline & - & + & (75) & - \\ \hline Net Income.. & & 1.153 & $357 & $289 \\ \hline \end{tabular} EXHIBIT 6.31 International Paper Product Line Segment Profitability Analysis (Case 6.3) \begin{tabular}{|c|c|c|c|c|} \hline & Year 10 & Year 9 & Year 8 & Year 7 \\ \hline \multicolumn{5}{|l|}{ Sales Mix } \\ \hline Printing Papers. & 26% & 29% & 28% & 27% \\ \hline & 23 & 21 & 22 & 22 \\ \hline & 22 & 24 & 22 & 22 \\ \hline & 16 & 16 & 17 & 17 \\ \hline & 13 & 10 & 11 & 12 \\ \hline & 100% & 100% & 100% & 10% \\ \hline \multicolumn{5}{|l|}{ Rate of Return on Assets } \\ \hline Printing Papers .+ & 2.1% & 15.3% & .3% & (1.9%) \\ \hline Packaging. & 6.9 & 17.9 & 9.5 & 6.2 \\ \hline & 8.1 & 7.3 & 6.1 & 5.3 \\ \hline Specialty Products. & (1.4) & 5.7 & 9.6 & 10.1 \\ \hline & 17.2% & 8.7% & 27,3% & 30.4% \\ \hline \multicolumn{5}{|l|}{ Profit Margin } \\ \hline Printing Papers .+ & 3.3% & 17.7% & .5% & (3.1%) \\ \hline & 8.5 & 16.8 & 8.7 & 6.1 \\ \hline & 2.3 & 2.1 & 2.1 & 1.8 \\ \hline & (1.5) & 6.3 & 10.3 & 10.7 \\ \hline Forest Products, & 34.7% & 18.5% & 24.4% & 28.7% \\ \hline \multicolumn{5}{|l|}{ Assets Turnover } \\ \hline & .65 & .87 & .66 & .60 \\ \hline & .81 & 1.07 & 1.09 & 1.03 \\ \hline & 3.47 & 3.46 & 2.86 & 2.89 \\ \hline & .96 & .91 & .93 & .94 \\ \hline & .50 & .47 & 1.12 & 1,06 \\ \hline \end{tabular} EXHIBIT 6.34 International Paper Statement of Cash Flows (amounts in millions) (Case 6.3) \begin{tabular}{|c|c|c|c|c|} \hline \multirow{3}{*}{ Operations } & \multicolumn{4}{|c|}{ Year Ended December 31: } \\ \hline & \multirow[t]{2}{*}{ Year 10} & \multirow[t]{2}{*}{ Year 9} & Year 8 & Year 7 \\ \hline & & & & \\ \hline & $303 & $1,153 & $357 & $289 \\ \hline & 1,194 & 1,031 & 885 & 898 \\ \hline Restructuring and Asset lmpairment Charges ..... & 680 & - & - & - \\ \hline Changes in Accounting Principles ................. & - & - & 75 & \\ \hline & (592) & - & - & - \\ \hline Other Addbacks and Subtractions ................... & 240 & 54 & 8 & 32 \\ \hline & $1,825 & $2,238 & $1,325 & $1,219 \\ \hline (Increase) Decrease in Accounts Receivable ......... & 192 & 45 & (339) & 78 \\ \hline (Increase) Decrease in Inventories ................. & 174 & (320) & 8 & (93) \\ \hline & (47) & 38 & (35) & 63 \\ \hline Increase (Decrease) in Accounts Payable ............ & (38) & 260 & 115 & (170) \\ \hline Increase (Decrease) in Other Current & & & & \\ \hline Liabilities ............................. & (367) & (13) & 169 & (168) \\ \hline Cash Flow from Operations.. & $1,739 & $2,248 & $1,243 & $929 \\ \hline \multicolumn{5}{|l|}{ Investing } \\ \hline & $(t,394) & $(1,518) & $(1,114) & $(971) \\ \hline & (1,586) & (I,038) & (396) & (151) \\ \hline Cash Flow from Investing... & $(2,980) & $(2,556) & $(1,510) & $(1,122) \\ \hline \multicolumn{5}{|l|}{ Financing } \\ \hline & $ & 57 & s- & $ \\ \hline Decrease in Short-Term Borrowing ................ & (23) & - & (115) & - \\ \hline & 1,909 & 1,505 & 1,059 & 1,276 \\ \hline & (375) & (950) & (275) & (1,016) \\ \hline & 100 & 66 & 67 & 225 \\ \hline & (291) & (237) & (210) & (208) \\ \hline & (39) & (91) & (231) & (67) \\ \hline Cash Flow from Financing.. & $1,281 & & $295 & \\ \hline & 540 & $42 & $28 & $17 \\ \hline & 312 & 270 & 242 & 225 \\ \hline & $352 & 5312 & $270 & $242 \\ \hline \end{tabular} EXHIBIT 6.35 International Paper Financial Statement Ratios (Case 6.3) \begin{tabular}{|c|c|c|c|c|} \hline . & Year 10 & Year 9 & Year 8 & Year 7 \\ \hline & 4.1% & 8.2% & 4.2% & 3.8% \\ \hline & .8 & .9 & .9 & .8 \\ \hline & 3.1% & 7.8% & 3.7% & 3.2% \\ \hline & 1.5% & 5.8% & 2.4% & 2.1% \\ \hline & 3.0 & 2.9 & 2.9 & 2.7 \\ \hline Rate of Return on Common Shareholders' Equity .......... & 3.5% & 16.1% & 5.6% & 4.7% \\ \hline \multicolumn{5}{|l|}{ Equity } \\ \hline & 79.9% & 75.4% & 80.0% & 80.8% \\ \hline & 13.0% & 11.9% & 12.9% & 13.1% \\ \hline & 2.6% & 2.5% & 2.3% & 2.3% \\ \hline & 1.7% & 3.6% & 1.6% & 1.5% \\ \hline & 7.9 & 8.2 & 7.3 & 7.4 \\ \hline & 5.7 & 6.1 & 5.8 & 5.6 \\ \hline & 1.3 & 1.7 & 1.5 & 1.4 \\ \hline & 1.0 & 1.2 & 1.2 & 1.1 \\ \hline & .5 & .6 & .6 & .5 \\ \hline Cash Flow from Operations/Average ....................... & 32.3% & 50.5% & 30.9% & 21.8% \\ \hline \multicolumn{5}{|l|}{ Current Liabilities } \\ \hline & 46 & 44 & 50 & 50 \\ \hline & 64 & 59 & 62 & 65 \\ \hline & 33 & 31 & 35 & 38 \\ \hline & 60.3% & 59.3% & 61.6% & 62.6% \\ \hline & 76.4% & 82.0% & 68.5% & 57.8% \\ \hline & 9.9% & 16.3% & 11,4% & 9.0% \\ \hline \multicolumn{5}{|l|}{ Total Liabilities } \\ \hline & 2.5 & 5.1 & 3.1 & 2.7 \\ \hline Cash Flow from Operations/Capital Expenditures ......... & 1.3 & 1.5 & 1.1 & 1.0 \\ \hline \end{tabular}