You have an opportunity to buy the Newton Falls Paper mill for $15 million Currently the mill sells standard paper reams and revenues total $6 million per year with fixed costs of $2 million and variable costs of 40 of revenue If you buy the facility your plan is to produce one or more specialty papers where you believe the margins are higher You would also like to update and modernize the mill To do this you will have to purchase two new paper machines for $1 5 million each and a new computer system for another $1 million You expect revenues to be $9 million year 1 $10 million year 2 $12 million year 3 and ongoing You expect your variable costs to equal 20 of revenues and your fixed costs to equal$4 5 million (depreciation expense is not included in this estimate of fixed costs) Assume depreciation on mill is $1 million per year and the machines and computer system is 3 year MACRS property If you paid the $15 million and operated the mill as it is now, meaning you earned the $6 million per year in revenues what would be your NPV If negative what would you have to pay to get a 0 NPV Should you purchase the mill and implement your plan of producing different paper What is the NPV Assume your sales projections are not what you thought and your sales are only $8 million each year going forward and variable costs jump to 25 of revenue while fixed costs remain $4 5 million what is your NPV What is your breakeven revenue to have at least a 0 NPV What does this mean If you take on this project how should you finance it What are some of the advantages and disadvantages of the different financing methods Assume you go with a capital structure of 50 debt and 50 equity, what is your net income and your NPV Now assume you choose 80 debt and 20 equity how does this change your net income and NPV To complete these questions you will need to compute the projects cost of capital For s 1 3 assume 100 equity financed so you will use the cost of equity to compute To get the cost of equity and cost of debt use International Paper as a proxy for this project In other words you can use its beta and cost of debt Assume a risk free rate of 1 and the market rate of 8 Assume a tax rate of 35 You can look up International Papers cost of debt and Beta online

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Sep 04, 2024

You have an opportunity to buy the Newton Falls Paper mill for $15 million. Currently the mill sells standard paper reams and revenues total $6

You have an opportunity to buy the Newton Falls Paper mill for $15 million. Currently the mill sells standard paper reams and revenues total $6 million per year with fixed costs of $2 million and variable costs of 40% of revenue. If you buy the facility your plan is to produce one or more specialty papers where you believe the margins are higher. You would also like to update and modernize the mill. To do this you will have to purchase two new paper machines for $1.5 million each and a new computer system for another $1 million.

You expect revenues to be:

$9 million year 1

$10 million year 2

$12 million year 3 and ongoing.

You expect your variable costs to equal 20% of revenues and your fixed costs to equal$4.5 million (depreciation expense is not included in this estimate of fixed costs). Assume depreciation on mill is $1 million per year and the machines and computer system is 3 year MACRS property.

If you paid the $15 million and operated the mill as it is now, meaning you earned the $6 million per year in revenues what would be your NPV? If negative what would you have to pay to get a 0 NPV?
Should you purchase the mill and implement your plan of producing different paper? What is the NPV?
Assume your sales projections are not what you thought and your sales are only $8 million each year going forward and variable costs jump to 25% of revenue while fixed costs remain $4.5 million what is your NPV? What is your breakeven revenue to have at least a 0 NPV? What does this mean?
If you take on this project how should you finance it? What are some of the advantages and disadvantages of the different financing methods?
Assume you go with a capital structure of 50% debt and 50% equity, what is your net income and your NPV? Now assume you choose 80% debt and 20% equity how does this change your net income and NPV?

To complete these questions you will need to compute the projects cost of capital. For #s 1-3 assume 100% equity financed so you will use the cost of equity to compute. To get the cost of equity and cost of debt use International Paper as a proxy for this project. In other words you can use its beta and cost of debt. Assume a risk free rate of 1% and the market rate of 8%. Assume a tax rate of 35%. You can look up International Papers cost of debt and Beta online.