Case Analysis – WorldWide

Paper Company
FINANCE MANAGEMENT

Submitted to:
Prof. A. Kanagraj

Asutosh Mishra (G19060) | Nikhil Kumar Sahu (G19077) | Rajdeep

Gupta (G19084) | Sakshi Mishra (G19086)
 Case Background

Bob Prescott, the controller of the Blue Ridge Mill had the alternative to add the new
on site longwood woodyard. Till then the Mill was purchasing the short wood from an
outside supplier, Shenandoah Mill. Shenandoah Mill was the competitor to Blue
Ridge Mill and used to sell the excess short wood to seven different mills including
Blue Ridge Mill.
This new woodyard would utilize new technology to process long wood, unlike
woodyard processing short wood. There were two major benefits of this woodyard for
Blue Ridge Mill.
First, Blue Ridge Mill would no longer be required to purchase longwoods from
Shenandoah Mill, but it would be self-sufficient for its longwood needs.
Second, by processing long wood it would have created the market for “Worldwide
Paper Company”. This step of Blue Ridge Mill would have created competition
between Blue Ridge Mill and Shenandoah Mill
The new addition of woodyard from Blue Ridge Mill would have two benefits for
Blue Ridge Mill. First, it would reduce the operating costs, once it starts Longwood
production. Second, it would increase the revenue for Blue Ridge Mill by selling this
product in Worldwide Paper Company.
Now Bob Prescott have to make the decision on whether to start this new woodyard
or continue with the existing arrangement. The decision would depend on whether the
expected benefits from this new woodyard would exceed the investment on it.
 Critical Financial Problems

Problem 1 - How could the operating cost be reduced since

purchasing shortwood from Shenandoah mill is increasing his overall
operation cost?

Blue Ridge Mill was purchasing the shortwood from Shenandoah mill because
the company was not in possession of the latest technology which would
enable them to use longwood directly.

The competitor was already producing the shortwood so it is evident that such
technology was already existing at that time.

Worldwide Paper company was not considering investing in this technology

which in turn resulted in comparatively high operating cost because of
purchasing of shortwood.

Problem 2 - Should the option of tapping into the unrealised revenue

generating opportunity of selling the shortwood in the open market
be considered by Bob Prescott?

Shenandoah mill was already selling shortwood in the open market hence its
evident that the market had demand for shortwood and Worldwide Paper
company was not leveraging this opportunity.

Shortwood market was a chance for Worldwide Paper company to generate

revenue and cut their operating cost at the same time. Analysis and
verification of the cost and revenue figures be done to arrive at a conclusion.

Problem 3 - What are the benefits of Investment of 18 million in

opening the new woodyard, when the recoverable amount is only 1.8
million?

Mr. Bob Prescott was considering investing 18 million for the inclusion of a
new on-site logwood woodyard. However, only 10 percent i.e. $1.8 million
can be recovered from the initial investment of $18 million

The future revenue figures are estimated and Mr. Prescot hopes to generate
enough revenue to offset the cost involved in this venture.
 But is this financial decision worth taking, given the low recoverability of
initial investment. Analysis of each possible scenario to find out the possible
financial implication of this venture be made to find out the suitability of this
option.

Problem 4 - Apart from the initial capital investment of 18 million,

there are also incremental investment involved. Is this incremental
investment justified given the revenue and cost figures estimated?
With his new venture, Bob would have to make incremental investment in
working capital apart from the required $18 million initial investment, over the
six-year life of the investment is also required.

The total working capital would average 10 percent of the annual revenues.
Therefore, the amount of working capital investment each year would equal 10
percent of incremental sales of the year.

With the given revenue figures and the cost estimates, can these figures
hamper company’s growth?

Problem 5 – How and what hurdle rate can be used to analyse this
investment if the one that is given is 10 years old and may not be
accurate currently?
Being such a huge amount, the net present value of this investment should be
identified and he given hurdle rate of 10% was based on a study of the company’s
cost of capital conducted 10 years earlier.

Obviously, this old discount rate cannot be used to calculate the Net Present Value of
this investment. Then, what can be the discount rate which we can use to calculate the
present value of this future cash flow.
 Analysis and Interpretation

In this case, we are analyzing Bob Prescott has to consider whether the addition of a
new on-site longwood woodyard will be beneficial or not. He has to check if these
benefits are more than initial $18 million capital investment. For this, the hurdle rate
which his company is using is very obsolete and he has to calculate the new rate.
Hurdle rate in capital budgeting is the term which means minimum rate that a
company wants to earn when investing in a project. Therefore, the hurdle rate is also
referred to as the company's required rate of return or target rate.
Also, we are using discounted cash flow method to get the net present value and IRR
value to check the viability of the project.

WACC Calculation:
WACC (Weighted Average Cost of Capital) is the weighted average of cost of a
company’s debt and the cost of its equity. WACC can be used as a hurdle rate against
which to assess return on capital invested performance. It also plays a key role
in economic value added (EVA) calculations. It is given by the below formula:
WACC= [Cost of Equity*%of Equity] + [Cost of Debt* % of Debt]

Where, Return of Equity or % of Equity= Rf + B*(Rm-Rf)

Rf- Risk Free Rate
B- Beta
Rm- Annual return of the market

Cost of Debt= Rd*(1-Tax rate)

Rd- market interest rate or the actual interest rate that the company is currently paying
on its obligations

From the given values we can calculate % of Equity= Rf + B*(Rm-Rf)

= 2.04 + 1.1 * 6
= 8.64
Here we have chosen Rf as 2.04 as the study which the company had conducted to
calculate hurdle rate is 10 years old where the yield rate of treasury bonds was
different. These same bonds are yielding at 2.04% at current value.
Cost of Debt: To calculate it we need to get the total interest expense on debts. WPC
has two components of debts, a bank loan and a long-term debt.
After applying the respective interests, we get the total value to be paid as debt =3107
Total value of the debt initially= 3000
So, we get the effective interest expense rate= 3.625%
Cost of Debt= Interest Expense*(1-Tax Rate)
= 3.625*0.6
=2.14

Now we will use these values in calculating WACC

WACC= [Cost of Equity*%of Equity] + [Cost of Debt* % of Debt]
= (2500/5500) *8.64 + (3000/5500) * 2.14
= 5.09
We will be using WACC as our discount rate.

Calculation of Net Present Value:

First, we will calculate the Operating Cash Flows whose calculations are shown in
table 1 below:

All figures in million dollars

Particulars 2016-Install 2017 2018 2019 2020 2021 2022
Revenue 4 10 10 10 10 10
Cost 3.2 8 8 8 8 8
Savings on OC 2 3.5 3.5 3.5 3.5 3.5
Depreciation 0 3 3 3 3 3
EBIT 2.8 2.5 2.5 2.5 2.5 2.5
Tax 1.12 1 1 1 1 1
Net Income 1.68 1.5 1.5 1.5 1.5 1.5
Depreciation 0 3 3 3 3 3
OCF 1.68 4.5 4.5 4.5 4.5 4.5
After the calculation of OCF we get the value of Net Present Value as shown in the
table 2.

OCF 1.68 4.5 4.5 4.5 4.5 4.5

NWC -0.4 -1 -1 -1 -1 4.4
Investment -16 -2 1.8
Total Proj CF -16 -0.72 3.5 3.5 3.5 3.5 10.7
NPV USD 2.90
IRR 9%
Table 2

Also, we have calculated the Internal Rate of Return whose value is 9% and discount
interest rate is 5.03%.

Interpretations:
1. NPV value which we have calculated is positive. Hence the World Wide
Company should take the project.
2. IRR is more than rate of return which means the company must invest in the
project.
 Solution and Implementation

After a thorough analysis of the possible of the case we arrived at the below values of
NPV and IRR:
NPV = $2.9 Million
IRR = 9%

For calculating the above values, the gives sales and cost figures were taken into
account.
We calculated the current discount rate which is 5.09%.
The company hurdle rate as per the policies was 10% which was based on a study
conducted 10 years ago ands hence should not be considered for evaluating the
investment opportunity.
The IRR calculated is greater than the current discount rate calculated and the NPV
for the investment option is positive.

Hence, we recommend that Mr. Bob Prescott should go ahead with investing 18
million in addition of a new on-site longwood woodyard.

The strategy formulated to invest in $18 million in 2 parts, $16 million in 2016 and $2
million in 2017, is appropriate as it is giving us positive NPV and favorable IRR
value.