기업분석#(World Wide Company)

Recommendation

 

Worldwide Paper Company (WPC) can gain expected benefits through addition of new on-site longwood woodyard. Through the capital budgeting, the calculation of the net present value (NPV) and the internal rate of return (IRR) show positive results. The IRR is a metric used in capital budgeting measuring the profitability of potential investments. The NPV is $831 million and The IRR is 11.1%. Even if the inflation rate is applied in capital budgeting, the NPV and the IRR are still positive. The NPV with inflation is 12.9% and The IRR is $1,988 million. In the end, through the addition of new equipment, WPC obtains more profits than their investment outlay.   

 

Statement Problem

 

Bob Prescott who is the controller for the Blue Ridge Mill, has to analyze capital budgeting of Worldwide Paper Company (WPC). This is in order to check the sufficiency of the expected benefits in comparison to the $18 million of investment outlay and incremental investment in working capital over the six years.

 

Analysis of Problem

 

 Worldwide Paper Company (WPC) was considering the addition of new on site longwood woodyard. Through the addition, WPC can eliminate the need to purchase shortwood from competitor company and create the opportunity to sell shortwood on the open market. Through the advantages, WPC can decrease operating costs and increase revenues. Prescott spends the $18 million investment outlay covering two years. Prescott analyzes whether expected benefits are enough to justify the $18 million capital outlay plus incremental investment in working capital over six years. 

 

 In order to find the effectiveness of longwood`s addition, analyzing capital budgeting is needed. First of all, WPC has to calculate their WACC. The existing WACC of 15% is based on old data. Through Exhibt1, which displays of interest rates in December 2006 and balance sheet, the WACC can be calculated. WPC has two cost of debt. WPC`s bond rating is A so one of the cost of debt is 5.78% and the other cost of debt is 5.38% because WPC used a bank loan. Cost of equity is calculated at 11.20%. The WPC`s value is $15,000 million. Equity value is $12,000 million and debt value is $3,000 million. Debt value also separates long term debt and bank loan payable. In the end, weight of equity is 80%, the long term debt`s weight is 3% and bank debt`s weigh is 17%. Through the variations, the WACC is 9.65%. This result differs from the existing WACC based on old data.

 

 The net present value can be calculated by using the WACC and the cash flows. There are two scenarios for free cash flows. The one is without inflation and the other is with inflation. WPC has to consider two situations. First of all, when inflation isn`t be applied, the net present value (NPV) is $831 million and internal rate of return (IRR) is 11.1%. In order to calculate these results, cash flows is need from 2008 and 2013. Prescott expected the sales revenue, which is $4 million in 2008. The other years` revenue is expected to $10 million. Cost of goods sold is 75% of sales. SG&A is 5% of sales. Operating savings is $ 2 million in 2008. The other year`s operating savings is $3.5 million. Depreciation is calculated on a straight line basis over the six-year with zero salvage so depreciation is 3,000 from 2008 to 2013. Through the variations, the earning before interest taxes (EBIT) is -$200 million in 2008 and the other year`s EBIT is $2,500 million.

 

 Through the EBIT, the net operating profit after tax (NOPAT) is -$120 million and the other year`s NOPAT is $1,500 million. The operating cash flow is equal to the NOPAT plus depreciation. The Free cash flow is equal to operating cash flow minus total investment. Prescott invests outlay of $18million covering two years and Investments from 2007 to 2013 are recovered in 2014 through equipment salvage and net working capital. The equipment salvage and the net working capital are $1,080 million and $1,000 million, respectively. In the end, free cash flow is $480 million million in 2008, $6,580 million in 2013 and the other year`s free cash flow is $4500 million. Through the free cash flow and WACC, net present value and internal rate of return can be calculated in Excel. The NPV is $831 and IRR is 11.1%

 

 Prescott also has to consider that inflation is applied in capital budgeting. Inflation ratio was 3.2% in 2006. Inflation increases the value of sales revenue, cost of goods sold and SG&A. Net working capital also increase the value because net working capital is influenced by sales revenue. In the end, the recovery`s amount of net working capital also increase from $1,000 million to $1,171 million. Through the increased variations, NPV and IRR can be calculated in Excel. The NPV is $1,988 million and The IRR is 12.9%. Through the results, Prescott can identify the expected benefits are much bigger than investment outlay and incremental investment in working capital over the six years.