Worldwide Paper Company Case solution Company Background December 2013, Lucy Lang, the controller for the Blue Ridge Mill, was considering the addition of a new on-site longwood woodyard. The addition would have two primary benefits:to eliminate the need to purchase shortwood from an outsider supplier and create the opportunity to sell short wood on the open market as a new market for Worldwide Paper Company (WPC). Now the new woodyard would allow the Blue Ridge Mill not only to reduce its operating costs but also increase its revenues. When the new woodyard began operating in 2015, it would significantly reduce the operating costs of the mill. These operating savings would come mostly from the difference in the cost of procuring short wood on-site versus buying it on the open market and were estimated to be $2.0 million for2015 and $3.5 million per year thereafter. Lang also planned on taking advantage of the excess production capacity afforded by the newfacility by selling shortwood on the open market as soon as possible. For 2015, she expected to show revenues of approximately $4 million, as the facility came on-line and began to break into the new market. She expected shortwood sales to reach $10 million in 2016 and continue at the$10 million level through 2020. Lang estimated that the cost of goods sold (before including depreciation expenses) would be 75% of revenues, and SG&A would be 5% of revenues. In addition to the capital outlay of $18 million, the increased revenues would necessitate higher levels of inventories and accounts receivables. The total working capital would average 10% of annual revenues. Therefore the amount of working capital investment each year would equal10% of incremental sales for the year. At the end of the life of the equipment, in 2020, all the networking capital on the books would be recoverable at cost, whereas only 10% or $1.8 million (before taxes) of the capital investment would be recoverable Primary Benefits of New Woodyard Eliminates the need to purchase short wood from an outside supplier (Shenandoah Mill) Creates the opportunity to sell short wood on the open market as a new market Reduces operating cost and increases revenue Problem Identification Whether the expected benefits were enough to justify the $18million capital outlay plus the incremental investment in working capital over the six-year life of the investment? Recommendation: The expected benefits are enough to justify the $18million capital outlay plus the incremental investment in working capital over the six-year l Annual Net Working Capital Years 2007 2008 2010 2011 2012 2013 Sales Revenue NWC (10 % of sales) 0 4000 10000 10000 10000 10000 Change NWC=chash 0 400 1000 1000 1000 1000 Flow 0 600 0 0 0 0 EXI-1 Years 2007 2008 2009 2010 2011 2012 2013 Investment capital outlay 16000 2000 0 0 0 0 0 Net working capital (10% sales) 0 400 600 0 0 0 0 Total Investment 16000 2400 600 0 0 0 0 Investment recovery: Equipment salvage (10 % total x (1-.4 for taxes) 18000 1080 Net Working capital ((full recovery) 1000 sales revenue 4000 10000 10000 10000 10000 10000 cost of goods sold (75% sales) 3000 7500 7500 7500 7500 7500 SG & A ( 5% Sales) 200 500 500 500 500 500 Operating savings 2000 3500 3500 3500 3500 3500 Ddepreciation (18000/6) 3000 3000 3000 3000 3000 3000 Total cost and expenses EBIT -200 2500 2500 2500 2500 2500 Taxes (40%) 80 1000 1000 1000 1000 1000 NOPAT -120 1500 1500 1500 1500 1500 Depreciation 3000 3000 3000 3000 3000 3000 investment -16000 -2400 -600 0 0 0 2080 Free cash flow -16000 600 3900 4500 4500 4500 6580 IRR = 11.1% NPV= 9.7% = $831 Worldwide paper company WACC Calculation We know, Bank loan payable 500 Debt= 500 + 2500 3000 Long term Debt 2500 Cost of debt = 5.8% 5.8 Shares outstanding 500 Current Market Price 24 Cost of equity= 4.6 + 1.10(6%) Equity= 500 x 24 2400 Beta 1.10% Market Premium 6% Risk free rate 4.60% Tax Rate 40 Debt= 20 Equity= 80 WACC Cost of Debt X debt %(1-Tax)+Cost of Equity X Equity % = 5.8 X .20(1-.4) +11.2 x .80 = 9.656 Annual Net Working Capital Years 2007 2008 2010 2011 2012 2013 Sales Revenue NWC (10 % of sales) 0 4000 10000 10000 10000 10000 Change NWC=cash 0 400 1000 1000 1000 1000 Flow 0 600 0 0 0 0 EXI-1 Years 2007 2008 2009 2010 2011 2012 2013 Investment capital outlay 16000 2000 0 0 0 0 0 Net working capital (10% sales) 0 400 620 20 21 21 22 Total Investment 16000 2400 620 20 21 21 22 Investment recovery: Equipment salvage (10 % total x (1-.4 for taxes) 18000 1080 Net Working capital ((full recovery) 1104 sales revenue 4000 10200 10404 10612.08 10824.32 11040.81 cost of goods sold (75% sales) 3000 7650 7803 7959.06 8118.241 8280.606 SG & A ( 5% Sales) 200 510 520.2 530.604 541.2161 552.0404 Operating savings 2000 3570 3641.4 3714.228 3788.513 3864.283 Ddepreciation (18000/6) 3000 3000 3000 3000 3000 3000 Total cost and expenses EBIT -200 2610 2722.2 2836.644 2953.377 3072.444 Taxes (40%) 80 1044 1088.88 1134.658 1181.351 1228.978 NOPAT -120 1566 1633.32 1701.986 1772.026 1843.467 Depreciation 3000 3000 3000 3000 3000 3000 investment -16000 -2400 620 20 21 21 2162 Free cash flow -16000 480 3946 4613.32 4680.986 4751.026 7005.467

1. What is the nature of the invesment that is under consideration and what are the sources of value?

2. Itemize the cashflow for each of the six years of the investment.

3. what are the components of the cost of capital and the weight used to get Worldwide Company WACC.

4. What are the NPV and the IRR of the resulting cash flows