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 life of the investment
“Invest in the new longwood Woodyard”
 Worldwide paper company

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
WACC Calculation
We know,
500 +
Bank loan payable 500 Debt= 2500 3000
Cost of debt =
Long term Debt 2500 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
 Worldwide paper company

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

IRR = 12.1%
NPV= 9.7% = $1483