Corporate Financial Management

World Wide Paper Company

Group Assignment – 1
GMP – Sec.B

Aayush Garg (G19051)

Aditya Prakash (G19054)
Anju Tayal (G19056)
Aditya Purander (G19081)
 Table of Contents

1. Case Background

2. Critical Financial Problems

3. Analysis and Interpretation

4. Specific recommendations and implementation

 General Background

In December 2006, Bob Prescott, the Controller at Blue Ridge Mill, was considering the addition
of a new on-site Longwood wood yard. This new wood yard utilizes a new technology that allowed
tree-length logs, called long woods, to be processed directly. Current Process requires short wood
that is purchased by Blue Ridge Mill from the Shenandoah mill. The Shenandoah Mill is owned
by a competitor to Blue Ridge Mill.
The primary benefits of a new wood yard will be that 1. It will eliminate the need to purchase short
wood from an outside supplier (in this case, the Shenandoah Mill). 2. It will create the opportunity
to sell short wood in the open market as a new market for Blue Ridge Mill. Thus Blue Ridge Mill
would be able to reduce its operating cost and increase its revenue.
II. Critical financial problems

Q1 what is the type of cash flow for this proposed project and what are sources of cost savings and
revenue generation.

The purpose of taking a project ins to bring about a positive change in the firm’s overall cash flows
and projected future cash flows, so to evaluate a proposed investment, we must take into account
the firm’s cash flows and determine whether they add value to the firm. The most crucial and initial
step is to determine which cash flows are relevant for the success. The relevant cash flow for the
project is considered to be a change that arises directly as a response to the decision to undertake
the project.

Q2 what is the net present value (NPV), and the internal rate of return (IRR) for this investment?

The most important feature of the net present value method is that it is based on the idea that dollars
received in the future are worth less than dollars in the bank today. Cash flow from future years is
discounted back to the present to find their worth. NPV Denotes the difference between present
values of the cash inflows and present value of cash outflows spread over the period of time and
hence is an imp tool in capital budgeting and investment employed majorly to determine the
profitability of a proposed investment. The Internal Rate of Return (IRR) is the discount rate that
makes the net present value (NPV) of a project zero. In other words, it is the expected compound
annual rate of return that will be earned on a project or investment. Once the internal rate of return
is determined, it is typically compared to a company’s hurdle rate or cost of capital. If the IRR is
greater than or equal to the cost of capital, the company would accept the project as a good
investment

Q3: What should be the minimum return that the world wide paper company must earn on the
proposed project to satisfy its creditors, owners, and other providers of capital.

Worldwide Paper Company is considering an investment of around $18M, in such a scenario it is

important to know the minimum return that the company has to earn to break even with the
creditors and investors.
Q4: The discount rate is an outdated figure and doesn’t take into consideration the recent inflation
rates. Prescott is thus highly skeptical of reliability of calculations involving the operating costs.
What should be a safe assumption for the per ton costs and prices to determine reliable dollar
estimates corrected for inflation? How much would these values determine the impact of new entry
into the market?

30-year treasury bonds had considered the return rate of 4.7% which has now lowered down to
2.82%. Since the real discount rate has decreased, it would take greater time to make NPV=0. The
impact of the discount rate thus changed will not lead to offsetting of the increased operating costs
by the increased revenues due to increased prices in the short-wood prices. So the new entry in
market would not be affected by these values.

Q5 what are the yearly cash flows that are relevant before taking the decision.

It is essential to estimate the annual cash flows before considering the investment decision. Cash
is also important because it later becomes payment for things that make your business run:
expenses like stock or raw materials, employees, rent and other operating expenses. Along with
debt management, strong cash flow provides the comfort and capabilities a business needs to invest
in growth. Building new locations, investing in research and development, renovating
infrastructure, improving technology, providing more training and purchasing more assets and
inventory are among the ways your business can grow and improve with strong positive cash flow.
 III Analysis and Interpretation

Total outflow = Capital investment + Working capital Outflow + Expenses

Total Inflow= Cost Savings + Revenue + Salvage Value of equipment + Working Capital Recovery

Net Cash flows = Inflows - Outflows

Year 2016 2017 2018 2019 2020 2021 2022

Capital Investment 16000000 2000000

Estimated sales 4000000 10000000 10000000 10000000 10000000 10000000

Working capital as % of sale 10% 10% 10% 10% 10% 10%

WC Outflow 400000 1000000 1000000 1000000 1000000 1000000

Expenses as percentage of
revenue 80% 80% 80% 80% 80% 80% 80%

Expenses - 3200000 8000000 8000000 8000000 8000000 8000000

Total Outflow 16000000 5600000 9000000 9000000 9000000 9000000 9000000

Inflow(Savings) 2000000 3500000 3500000 3500000 3500000 3500000

Inflow(Revenues-COGS-SG&A) 4000000 10000000 10000000 10000000 10000000 10000000

Salvage Value 1800000

Working capital recovery 5400000

Total Inflow 0 6000000 13500000 13500000 13500000 13500000 20700000

Net Cash Flows -16000000 400000 4500000 4500000 4500000 4500000 11700000
Calculation of WACC:

Bank loan Payable 500 Debt = 3000

Cost of
Long Term Debt 2500 Debt=5.8% 5.8

Shares Outstanding 500

Current Market
Price 24 Equity 12000
Cost of Equity 4.6+1.10(6%)
Beta 1.10%
Market Premium 6%
Risk Free Rate 4.60%
Tax Rate 40

Debt= 20

WACC Cost of Debt X debt%(1-Tax)+Cost of Equity X Equity %

5.8X0.20(1-0.4)+11.2 X 0.80
9.656

Net Present Value (NPV)

Net Present Value is the difference between the sum of the present values of the future cash
flows of the project and the initial cost of the project. Companies use weighted average cost of
capital as the discount rate to calculate the NPV.
Net Present Value = PV of cash inflows – PV of cash outflows

Year Cash flows PV Factor at 9.65% Present Value

0 (16000000) 1 ($16000000)
1 400000 0.911 364400
2 4500000 0.831 3739500
3 4500000 0.758 3411000
4 4500000 0.691 3109500
5 4500000 0.630 2835000
6 11700000 0.575 6727500
NPV = $ 4186900

Since NPV is positive, it is a positive sign to go for the project

Some other points to note are as follows:

 WPC had originally estimated this investment opportunity using a hurdle rate of 15%
which was outdated.
 The hurdle rate was based on a 10 year old cost of capital study
 Using an outdated hurdle rate would therefore skew investment opportunity calculations.
 In the base case, the cash flows were discounted using the calculated WACC of 9.65%