Worldwide Paper

1272 Words Apr 25th, 2011 6 Pages
What is the nature of the investment that is under consideration and what are the sources of value (cost savings and revenue increases)? The investment proposed by Bob Prescott, an on-site longwood woodyard, would reduce operating costs by processing tree-length logs, as well as increase revenues by selling shortwood.
Cost Savings: In 2006, Worldwide Paper’s Blue Ridge Mill had to purchase shortwood from competitor, Shenandoah Mill. The new woodyard would begin operations in 2008, thus saving Blue Ridge Mill $2mm in year one and $3.5mm the years after. The savings would come from the difference in the cost of producing shortwood on-site versus purchasing it on the open market.
Revenues:
Revenues would be generated by
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Net working capital is estimated to be 10% of annual revenues (10M). This requires the project to maintain a $1M NWC level from 2009-2012 ($400k in 2008) and a $0 NWC in 2013. This will result in a positive cash flow of $1M.
Revenue, COGS, SG&A – Revenues are estimated to be $4M in the first year of operation (2008), and then reach $10M for the remainder of the project. COGS will be calculated as 75% of annual revenues, and SG&A costs will be 5% of annual revenues.
Operating Savings – these cash flows are captured in the cash flows resulting from operations. Savings were estimated to be $2M in the first operational year (2008), and $3.5M thereafter.

What discount rate should Worldwide Paper Company (WPC) use to analyze those cash flows? Justify the recommended rate and identify the assumptions used to estimate it. What are the components of the cost of capital and the weights used to get Worldwide’s WACC? Bob Prescott, Controller at the Blue Ridge Mill, has two options with respect to the discount rate; adhere to company policy and use the existing corporate cost of capital rate of 15%, or gather the necessary data inputs to calculate a new weighted average cost of capital (WACC). Our team of analysts is in firm agreement with Mr. Prescott’s apprehension as it relates to the validity of the existing corporate cost of capital and therefore supports his

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