Bob The Builder, CEO of Worldwide Paper Company (WPC) is considering



Bob The Builder, CEO of Worldwide Paper Company (WPC) is considering the addition of a new on-site longwood woodyard. The addition would have two primary benefits: it would eliminate the need to purchase shortwood from an outside supplier and would create the opportunity to sell shortwood on the open market as a new revenue opportunity for WPC.

The new woodyard would allow the company not only to reduce its operating costs but also to increase its revenues. The proposed woodyard utilizes new technology that allows tree-length logs, called longwood, to be processed directly, whereas the current process requires shortwood, which has to be purchased from the Shenandoah Mill. This nearby mill, owned by a competitor, has excess capacity that allows it to produce more shortwood than it needs for its own pulp production. The excess is sold to several different mills, including WPC. Thus adding the new longwood equipment would mean that Bob would no longer need to use the Shenandoah Mill as a shortwood supplier and that WPC would instead compete with the Shenandoah Mill by selling on the shortwood market.

The question for Bob is whether these expected benefits are enough to justify the $19.00 million capital outlay plus the incremental investment in working capital over the 8-year life of the investment.

Construction would start within a few months, and the investment outlay would be spent over two calendar years: $12.00 million in 2014 and the remaining $7.00 million in 2015. When operation begins in 2015, the new woodyard 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 are estimated to be $2.00 million for 2015 and $3.50 million per year thereafter.

Bob also plans on taking advantage of the excess production capacity offered by the new facility by selling shortwood on the open market as soon as possible. For 2015, he expects to show revenues of approximately $4 million, as the facility comes on-line and begins to break into the new market. He expects shortwoood sales to reach $10 million in 2015 and continue at the $10 million level through the useful life of the project. Bob estimates that the cost of goods sold (before including depreciation expenses) would be 68.00% of revenues, and SG&A would be 6.00% of revenues.

In addition to the capital outlay of $19.00 million, the increased revenues would require 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, all the net working capital on the books could be recovered at cost, whereas only 10% (before tax) of the capital investment would be recovered.

Taxes is paid at a 40.00% rate, and depreciation is calculated on a straight-line basis over the useful life, with a $3.80 million salvage value. WPC accountants told Bob that the depreciation charges could not begin until the whole capital investment had been spent, and the machinery was in service.

WPC has a company policy to use 15% as the hurdle rate for such investment opportunities.

Under “Section A. Provided Data”, complete the list of value drivers.

a.Under “Section B. DCF Model”, following the appropriate time line, calculate the annual FCFs and the project’s internal rate of return.

b.Write a short interpretation of the results and a brief investment recommendation addressed to Bob The Builder.

Show your work under “Section C. Analysis”.
Pick two independent variables of your choice and replace those variables with combo boxes. Each combo box should offer at least 5 different choices. Make sure that all the choices maintain the model integrity.

Explain how sensitive WPC’s investment project is to the two chosen independent variables.

*I have completed question A and B(a)*
*Please do B(b) and C*
*Please use Scenario tool and any financial functions if necessary*


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