In January 2016, Bob Prescott, the controller for the Blue Ridge Mill, was considering the addition...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
In January 2016, Bob Prescott, 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 outside supplier and create the opportunity to sell shortwood 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 to increase its revenues. The proposed woodyard utilized new technology that allowed tree-length logs, called longwood, to be processed directly, whereas the current process required shortwood, which had to be purchased from the Shenandoah Mill. This nearby mill, owned by a competitor, had excess capacity that allowed it to produce more shortwood than it needed for its own puip production. The excess was sold to several different mills, including the Blue Ridge Mill. Thus adding the new longwood equipment would mean that Prescott would no longer need to use the Shenandoah Mill as a shortwood supplier and that the Blue Ridge Mill would instead compete with the Shenandoah Mill by selling on the shortwood market. The question for Prescott was whether these expected benefits were enough to justify the $18 million capital outlay plus the incremental investment in working capital over the six-year life of the investment. Construction would start within a few months, and the investment outlay would be spent over two calendar years: $16 million in 2016 and the remaining $2 million in 2017. When the new woodyard began operating in 2017, it would significantly reduce the operating costs of the mill. These operating savings would come mostly from the difference in the cost of producing shortwood on-site versus buying it on the open market and were estimated to be $2.0 million for 2017 and $3.5 million per year thereafter. Prescott also planned on taking advantage of the excess production capacity afforded by the new facility by selling shorrwood on the open market as soon as possible. For 2017, he expected to show revenues of approximately $4 million, as the facility came on-line and began to break into the new market. He expected shortwood sales to reach $10 million in 2018 and continue at the $10 million level through 2022 Prescott 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 receivable. The total working capital would average 10% of annual revenues. Therefore the amount of working capital investment each year would equal 10% of incremental sales for the year. At the end of the life of the equipment, in 2022, all the net working capital on the books would be recoverable at cost, whereas only 10% or $1.8 million (before taxes) of the capital investment would be recoverabic. Taxes would be paid at a 40% rate, and depreciation was calculated on a straight-line basis over the six- year life, with zero salvage. WPC accountants had told Prescott that depreciation charges could not begin until 2017, when all the $18 million had been spent, and the machinery was in service. or redistribute. Contact permiss Page 2 Prescott was conflicted about how to treat inflation in his analysis. He was reasonably confident that his estimates of revenues and costs for 2017 and 2018 reflected the dollar amounts that WPC would most likely experience during those years. The capital outlays were mostly contracted costs and therefore were highly reliable estimates. The expected shortwood revenue figure of $4.0 million had been based on a careful analysis of the shortwood market that included a conservative estimate of the Blue Ridge Mill's share of the market plus the expected market price of shortwood, taking into account the impact of Blue Ridge Mill as a new competitor in the market. Because he was unsure of how the operating costs and the price of shortwood would be impacted by inflation after 2018, Prescott decided not to include it in his analysis. Therefore the dollar estimates for 2019 and beyond were based on the same costs and prices per ton used in 2018. Prescott did not consider the omission critical to the final decision because he expected the increase in operating costs caused by inflation would be mostly offset by the increase in revenues associated with the rise in the price of shortwood. 2000 2 / 3 WPC had a company policy to use 10% as the hurdle rate for such investment opportunities. The hurdle rate was based on a study of the company's cost of capital conducted 10 years ago. Prescott was uneasy using an outdated figure for a discount rate, particularly because it was computed when 30-year Treasury bonds were yielding 4.7%, whereas currently they were yielding less than 3% (Exhibit 1). 000 000 F4 F5 F6 O 8 = UVA-F-1372 * DII FB 9 FY Bank loan rates (LIBOR) 1.15% 1-year Government bonds 1-year 5-year 10-year 30-year 80 F3 000 000 F4 0.49% 1.46% 2.04% 2.82% % 5 TE $ 4 worldwide Paper Company Cost-of-Capital Information Other Interest Rates: January 15, 2016 Per-share data Balance-sheet accounts (in millions of dollars) Bank loan payable (LIBOR + 1%) Long-term debt Common equity Retained earnings FS Worldwide Paper Financial Data Bond rating Beta Shares outstanding (millions) Book value per share Recent market value per share < Market risk premium Historical average 6 (C Corporate bonds (10-year maturities) 2.45% 3.38% 3.85% 5.05% Aaa Aa A Baa F6 87 & 44 F7 500 2,500 500 2,000 500 $ 5.00 $24.00 1.10 * A 8 6.0% DII FB ( 9 4 $10 J10 3 NPV Inputs 4 Project Years 5 Capex in 2016 6 Capex in 2017 A 1 Worldwide Paper Case 2 9 7 Cost Savings in 2017 8 Cost Savings post-2017 Revenue 2017 10 Revenue post-2017 11 COGS as % Revenue 12 SG&A as % Revenue AHASA2208 13 NOWC as % Revenue 16 Inflation 2020 on 14 Salvage Value as % Capital Outlay 15 Taxes 18 19 17 Company Policy Hurdle Rate 21 23 24 25 26 27 28 29 x 30 31 32 > 33 34 35 36 37 fx NPV + Project Year: Calendar Year: Revenue Cost Savings COGS SG&A EBITDA Dep EBIT Taxes Net Income C NOWC OCF Capital Imanetment D WACC Inputs Risk-Free Rate MRP Beta Cost of Debt Debt Share price Shares Out 0 2016 E 1 2017 2 2018 G WACC Outputs Cost of Equity After-Tax Cost of Debt MV of Equity D/{[DE] EAD+E) WACC 3 2019 4 2020 5 2021 ta Format 2022 NOWC OCF Capital investment NOW Cinvestment Sales of Depreciable Fixed Asset BV of Asset Gain (Loss) Tax on Gain (Loss) After-Tax Salvage Value FCF NPV @ Policy Hurdle Rate NPV at WACC IRR MIRR MacBook Pro 8 DD 19 J $10 pay In January 2016, Bob Prescott, 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 outside supplier and create the opportunity to sell shortwood 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 to increase its revenues. The proposed woodyard utilized new technology that allowed tree-length logs, called longwood, to be processed directly, whereas the current process required shortwood, which had to be purchased from the Shenandoah Mill. This nearby mill, owned by a competitor, had excess capacity that allowed it to produce more shortwood than it needed for its own puip production. The excess was sold to several different mills, including the Blue Ridge Mill. Thus adding the new longwood equipment would mean that Prescott would no longer need to use the Shenandoah Mill as a shortwood supplier and that the Blue Ridge Mill would instead compete with the Shenandoah Mill by selling on the shortwood market. The question for Prescott was whether these expected benefits were enough to justify the $18 million capital outlay plus the incremental investment in working capital over the six-year life of the investment. Construction would start within a few months, and the investment outlay would be spent over two calendar years: $16 million in 2016 and the remaining $2 million in 2017. When the new woodyard began operating in 2017, it would significantly reduce the operating costs of the mill. These operating savings would come mostly from the difference in the cost of producing shortwood on-site versus buying it on the open market and were estimated to be $2.0 million for 2017 and $3.5 million per year thereafter. Prescott also planned on taking advantage of the excess production capacity afforded by the new facility by selling shorrwood on the open market as soon as possible. For 2017, he expected to show revenues of approximately $4 million, as the facility came on-line and began to break into the new market. He expected shortwood sales to reach $10 million in 2018 and continue at the $10 million level through 2022 Prescott 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 receivable. The total working capital would average 10% of annual revenues. Therefore the amount of working capital investment each year would equal 10% of incremental sales for the year. At the end of the life of the equipment, in 2022, all the net working capital on the books would be recoverable at cost, whereas only 10% or $1.8 million (before taxes) of the capital investment would be recoverabic. Taxes would be paid at a 40% rate, and depreciation was calculated on a straight-line basis over the six- year life, with zero salvage. WPC accountants had told Prescott that depreciation charges could not begin until 2017, when all the $18 million had been spent, and the machinery was in service. or redistribute. Contact permiss Page 2 Prescott was conflicted about how to treat inflation in his analysis. He was reasonably confident that his estimates of revenues and costs for 2017 and 2018 reflected the dollar amounts that WPC would most likely experience during those years. The capital outlays were mostly contracted costs and therefore were highly reliable estimates. The expected shortwood revenue figure of $4.0 million had been based on a careful analysis of the shortwood market that included a conservative estimate of the Blue Ridge Mill's share of the market plus the expected market price of shortwood, taking into account the impact of Blue Ridge Mill as a new competitor in the market. Because he was unsure of how the operating costs and the price of shortwood would be impacted by inflation after 2018, Prescott decided not to include it in his analysis. Therefore the dollar estimates for 2019 and beyond were based on the same costs and prices per ton used in 2018. Prescott did not consider the omission critical to the final decision because he expected the increase in operating costs caused by inflation would be mostly offset by the increase in revenues associated with the rise in the price of shortwood. 2000 2 / 3 WPC had a company policy to use 10% as the hurdle rate for such investment opportunities. The hurdle rate was based on a study of the company's cost of capital conducted 10 years ago. Prescott was uneasy using an outdated figure for a discount rate, particularly because it was computed when 30-year Treasury bonds were yielding 4.7%, whereas currently they were yielding less than 3% (Exhibit 1). 000 000 F4 F5 F6 O 8 = UVA-F-1372 * DII FB 9 FY Bank loan rates (LIBOR) 1.15% 1-year Government bonds 1-year 5-year 10-year 30-year 80 F3 000 000 F4 0.49% 1.46% 2.04% 2.82% % 5 TE $ 4 worldwide Paper Company Cost-of-Capital Information Other Interest Rates: January 15, 2016 Per-share data Balance-sheet accounts (in millions of dollars) Bank loan payable (LIBOR + 1%) Long-term debt Common equity Retained earnings FS Worldwide Paper Financial Data Bond rating Beta Shares outstanding (millions) Book value per share Recent market value per share < Market risk premium Historical average 6 (C Corporate bonds (10-year maturities) 2.45% 3.38% 3.85% 5.05% Aaa Aa A Baa F6 87 & 44 F7 500 2,500 500 2,000 500 $ 5.00 $24.00 1.10 * A 8 6.0% DII FB ( 9 4 $10 J10 3 NPV Inputs 4 Project Years 5 Capex in 2016 6 Capex in 2017 A 1 Worldwide Paper Case 2 9 7 Cost Savings in 2017 8 Cost Savings post-2017 Revenue 2017 10 Revenue post-2017 11 COGS as % Revenue 12 SG&A as % Revenue AHASA2208 13 NOWC as % Revenue 16 Inflation 2020 on 14 Salvage Value as % Capital Outlay 15 Taxes 18 19 17 Company Policy Hurdle Rate 21 23 24 25 26 27 28 29 x 30 31 32 > 33 34 35 36 37 fx NPV + Project Year: Calendar Year: Revenue Cost Savings COGS SG&A EBITDA Dep EBIT Taxes Net Income C NOWC OCF Capital Imanetment D WACC Inputs Risk-Free Rate MRP Beta Cost of Debt Debt Share price Shares Out 0 2016 E 1 2017 2 2018 G WACC Outputs Cost of Equity After-Tax Cost of Debt MV of Equity D/{[DE] EAD+E) WACC 3 2019 4 2020 5 2021 ta Format 2022 NOWC OCF Capital investment NOW Cinvestment Sales of Depreciable Fixed Asset BV of Asset Gain (Loss) Tax on Gain (Loss) After-Tax Salvage Value FCF NPV @ Policy Hurdle Rate NPV at WACC IRR MIRR MacBook Pro 8 DD 19 J $10 pay
Expert Answer:
Answer rating: 100% (QA)
Discount rate WACC 349 WACC Debt percentage of capitalcost of debt1t equ... View the full answer
Related Book For
Managerial Economics Theory Applications and Cases
ISBN: 978-0393912777
8th edition
Authors: Bruce Allen, Keith Weigelt, Neil A. Doherty, Edwin Mansfield
Posted Date:
Students also viewed these accounting questions
-
In December 2006, Bob Prescott, 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...
-
The Berwyn Company is considering the addition of a new product to its product line. The firm has plenty of excess manufacturing capacity to produce the new product, and its total fixed costs would...
-
A producer of pottery is considering the addition of a new plant to absorb the backlog of demand that now exists. The primary location being considered will have fixed costs of $ 9,200 per month and...
-
02. The competitive exclusion principle only applies when the niches of competing species have a high degree of overlap. O True False 54bmit Q3. Four snake species colonize an island at the same...
-
The following figure shows the supply and demand for strawberries. Answer the questions that follow. Supply and Demand of Strawberries a. Indicate the equilibrium price and equilibrium quantity. b....
-
Consider the information given in the following table on four consumers in the market for premium bottled water. a. If the price of a bottle of premium bottled water is $1.50, what is the total...
-
Remember, it is important to draft the motion for summary judgment sufficiently in advance of the hearing date in order to allow time to serve and file the motion. Review CCP 437c, which governs...
-
The Webster National Bank is reviewing its service charges and interest-paying policies on checking accounts. The average daily balance on personal checking accounts is $550, with a standard...
-
Comparative financial statements for Weller Corporation for the fiscal year ending December 31 appear below. The company did not issue any new common or preferred shares during the year. A total of...
-
Mr. M has been employed as an engineer by A Ltd., a company incorporated in Hong Kong. During the year ended 31 March 2019, Mr. M had the following income and expenditure. A monthly salary of...
-
Question 10 Consider a Siamese Twins company, called XY, with its two parts X and Y. X and Y are listed both in the US and in the UK, but X is mainly traded in the US and Y is mainly traded in the...
-
Fill in the Blank. In Laplace domain, \(\lim _{s ightarrow 0}[s X(s)]\) gives ___________ value of the response.
-
Fill in the Blank. A change in momentum of a system gives the ___________ .
-
Fill in the Blank. Total response of a system is composed of transient and ___________ values.
-
If you were being assigned to a foreign position, what specific training requests would you make of your employer?
-
Which are easier to assess, business skills or international skills? Why?
-
Preparing Entry to Issue Common Stock On June 30, Ebae Inc. issued 120 shares of $1 par value common stock for $12 per share. Prepare Ebae's June 30 journal entry for stock issuance. Date Account...
-
When an electric field is applied to a shallow bath of vegetable oil, why do tiny bits of thread floating in the oil align with the field like compasses in a magnetic field?
-
The Klein Corporation's marketing department, using regression analysis, estimates the firm's demand function, the result being Q = - 104 - 2.1P + 3.2I + 1.5A + 1.6Z R2 = 0.89 Standard error of...
-
James Pizzo is president of a firm that is the industry price leader; that is, it sets the price and the other firms sell all they want at that price. In other words, the other firms act as perfect...
-
Consider a father who is trying to discipline his child. The father insists that the child must go with the rest of the family to visit their grandmother. The child prefers to go to the movies with a...
-
Preferred shares are least likely to have which of the following characteristics? a. Preference as to assets on liquidation of the corporation b. Extra liability for the preferred shareholders c. The...
-
The contributed capital portion of shareholders' equity does not include a. preferred shares. b. contributed surplus c. retained earnings. d. common shares.
-
Which of the following is true about stated value? a. It represents what a share is worth. b. It represents the original selling price for a share. c. It is established for a share after it is...
Study smarter with the SolutionInn App