Worldwide

Paper Co.
Team D

Mercedes Gonzalez
Bill McCoy
Jaclyn Meunier
Molly Golden

The Worldwide Paper Company (WPC) currently owns Blue Ridge Mill. In December of
2006, Bob Prescott, controller of the mill, was faced with the decision of whether the company
should invest in an on-site woodyard for the mill or not. There are two main potential benefits
the woodyard can bring the company. The first benefit is that having their own woodyard would
eliminate WPCs need to purchase shortwood from an outside supplier. Currently, the company
is purchasing shortwood from the Shenandoah Mill. Not only is WPC paying mark up on the
wood, theyre also supporting a competitor because a competitor owns the Shenandoah Mill.
Being able to produce their own wood via the woodyard project could save on the companys
costs significantly in the long run, while also cutting a competitors revenues. The second benefit
of the investment would be an opportunity for WPC to break into a new market by selling excess
shortwood on the open market, similar to what the Shenandoah Mill is currently doing. While the
investment has these potential benefits, its necessary for Prescott to evaluate these benefits
versus the costs to determine whether the woodyard is a sound investment.
The costs of this investment would include an $18 million investment outlay, plus
increased investment in working capital for 6 years. The outlay would be split over two years,
$16 million spent in 2007 and $2 million spent in 2008. The increase in net working capital
(NWC) would be 10% of revenues per year, meaning the NWC investment would be 10% of
incremental sales each year. However, at the end of the life of the equipment all of the NWC is
recoverable, along with 10% ($1.8 million) of the capital investment. Prescott also estimated that
cost of goods sold would amount to 75% of revenues and selling, general, and administrative
costs would be 5% of revenues. The company has a 40% tax rate and the depreciation will be
calculated straight line basis for 6 years with no salvage value.
The investment also offers savings for the company. While the bulk of the investment
cost takes place in 2007, the woodyard wont begin operating until construction is completed in
2008. However, when the woodyard does begin running, it should significantly cut down on
operating costs for the mill. The estimated savings on producing shortwood versus buying it on
the market is $2 million in 2008 and $3.5 million per year after that. Additionally, Prescott is
expecting to utilize the production capacity by selling the excess shortwood in the open market.
He proposes that their breakthrough year will produce $4 million in revenues. He expects
shortwood sales to grow to $10 million in 2009, and remain at that amount through 2013.
The big issue for this project is determining whether the revenues and savings outweigh
the costs. To do so, we decided finding the projects net present value (NPV) and internal rate of
return (IRR) would be the best way to analyze this. We picked these factors because the net
present value is a calculation to find the difference in the present value of capital inflows
supported by the project and the present value of outflows in relation to the cost of the project.
This will show us if our projects expected value is positive when accounting for the time value
of money. We chose to include the IRR calculation because its the discount rate that makes the
net present value of all cashflows from a project equal to zero. The IRR can be compared to the
companys cost of capital to determine if a project is viable. If the IRR is higher than the cost of
capital, a company will most likely accept the project. Worldwide Paper Company currently has
a policy to use a cost of capital of 15% to analyze investments. However, Prescott believes this

number is inaccurate due to the fact that the company has not updated it in over 10 years. The
figure was calculated when Treasury bonds were yielding 10%and theyre currently yielding less
than 5%. For these reasons, in order to calculate the NPV and IRR, we must first calculate an
updated weighted average cost of capital (WACC) for the WPC.

Exhibit 1

Cost of Capital Information

Interest Rates: December 2006
Bank Loan Rates (LIBOR)
Market Risk Premium
1-Year
5.38% Historical Avg
6.00%
Corporate Bonds (10yr
Government Bonds
Maturities)
1-Year
4.96% Aaa
5.37%
5-Year
4.57% Aa
5.53%
10-Year
4.60% A
5.78%
30-Year
4.73% Baa
6.25%
Worldwide Paper Financial Data
Balance Sheet Accounts ($ millions)
Bank loan payable (LIBOR + 1%)
500
Long Term Debt
2500
Common Equity
500
Retained Earnings
2000
Per-Share Data
Shares
Outstanding
(Millions)
Book Value/Share
Market Value/Share
Other
Bond Rating
Beta
Tax Rate

500
$5.00
$24.00

A
1.1
40%

The formula to calculate the WACC is WACC= (We*Re) + (Wd*Rd)*(1-Tax) where We

and Re are the weight and cost of equity, Wd and Rd weight and cost of debt, and Tax is the tax
rate percentage. Our first step in determining the WACC was to find the weights of debt and
equity. We referred to Exhibit 1 supplied by Prescott to determine that the companys total debt
equals $3,000 million by adding short term debt ($500 million) to long term debt ($2,500). Next,
we found the companys market equity value by multiplying their 500 million shares outstanding
by a market value per share of $24.00 to give us an equity of $12,000 million. To determine the
weight of debt, we simply divided the $3,000 million value of debt by the total $15,000 million

value of the firm. This gave us a weight of debt of 20%, meaning the companys weight of equity
equals 80%.
Our next step was to find the cost of debt, Rd. Referring to Exhibit 1, we found that bank
loan rates (LIBOR) are 5.38%. However, theres a 1% premium on the companys short term
bank loans, making the cost of these 6.38%. Because the short term and long term debt have
different costs, we found the weight of each and multiplied them by their perspective costs. The
weight of short term debt is 16.67%, or $500m/3,000m. We then multiplied this by the cost of
6.68% to come up with 1.0634% cost of debt. The weight of long term debt is 2500/3000, or
83.33%. We multiplied this by the LIBOR rate of 5.38% to come up with a cost of 4.858%.
Next, we added these together to get a before tax cost of debt of 5.92%.
To find our cost of equity we used the CAPM formula. This formula is Re= rf + (rm-rf),
where Re is the cost of equity, rf is the risk free rate, is the companys beta, and rm-rf is the
market risk premium. We decided to use the 10-year bond rate as our risk free rate, which is
found in Exhibit 1 as 4.60%. The market risk premium was stated as 6.00% and the companys
beta is 1.10. We plugged these numbers into the equation to find a cost of equity, Re, of 11.2%.
Finally, we plugged our weights and costs of equity and debt into the WACC, giving us
the formula WACC= (.80*.112) + (.20*.0592)(1-.40). After completing the calculation, we
determined a weighted average cost of capital of 9.67%.

Exhibit 2
Initial
Investment
Sales
COGS
Selling and
Admin.
Increase in
NWC
Gross Profit
Operating
Savings
Depreciation
EBIT
Taxes (.40)
Net Profit
After Tax
Add
Depreciation
Net Income
Recoverable

Net Present Value and Internal Rate of Return for WPC Woodyard Project
2007
2008
2009
2010
$ (16,000,000)

$ (2,000,000)

2011

2012

2013

$ 4,000,000

$ 10,000,000

$ 10,000,000

$ 10,000,000

$ 10,000,000

$ 10,000,000

$ (3,000,000)

$ (7,500,000)

$ (7,500,000)

$ (7,500,000)

$ (7,500,000)

$ (7,500,000)

(200,000)

(400,000)

$ (1,000,000)

$ (1,000,000)

$ (1,000,000)

$ (1,000,000)

$ (1,000,000)

400,000

$ 1,000,000

$ 1,000,000

$ 1,000,000

$ 1,000,000

$ 1,000,000

$ 2,000,000

$ 3,500,000

$ 3,500,000

$ 3,500,000

$ 3,500,000

$ 3,500,000

$ (3,000,000)

$ (3,000,000)

$ (3,000,000)

$ (3,000,000)

$ (3,000,000)

$ (3,000,000)

(600,000)

$ 1,500,000

$ 1,500,000

$ 1,500,000

$ 1,500,000

$ 1,500,000

240,000

(600,000)

(600,000)

(600,000)

(600,000)

(600,000)

(360,000)

900,000

900,000

900,000

900,000

900,000

$ 3,000,000

$ 3,000,000

$ 3,000,000

$ 3,000,000

$ 3,000,000

$ 3,000,000

$ 2,640,000

$ 3,900,000

$ 3,900,000

$ 3,900,000

$ 3,900,000

$ 3,900,000

$ 7,200,000

(500,000)

(500,000)

(500,000)

(500,000)

(500,000)

Costs
Free Cash
Flow
Tax Rate
WACC

NPV
IRR

$ (16,000,000)

640,000

$ 3,900,000

$ 3,900,000

$ 3,900,000

$ 3,900,000

$ 11,100,000

0.4
9.67%

$2,316,634.72
13.28%

With our new cost of capital, our next step was to calculate the net present value and
internal rate of return for this investment. We created an Excel file to help us calculate these
figures, found in Exhibit 2 above.
The first phase in creating our Excel file was to plot the cash flows relevant to the project
in the years they occur because the NPV calculation takes the time value of money into account.
In Exhibit 2, you can see that the initial investment, cost of goods sold, selling and administrative
costs, increase in net working capital, depreciation, and taxes are the costs associated with this
project. The initial investment amounts were given to us by Bob Prescott. We calculated the
COGS by multiplying the estimated 75% by the total sales. Similarly, we calculated selling and
administrative costs by multiplying sales by the estimated 5%. The increase in net working
capital necessary for the project is 10% of sales, and this amount will be recoverable in the final
year. We were told that the project is to be depreciated on a straight line basis over 6 years,
giving us a depreciation deduction of $3,000,000 per year. Finally, the corporate tax rate is 40%
for Worldwide Paper Co., so we multiplied this and our earnings before interest and taxes to find
the tax cost.
The capital inflows relevant to the project include sales, operating savings, and
recoverable costs. Prescott estimated that selling the excess shortwood in the open market would
bring in revenues of $4,000,000 in 2008 and $10,000,000 per year each year following. The
operating savings are the costs saved by no longer purchasing shortwood from an outside source.
Prescott estimated $2,000,000 in savings for 2008 and $3,500,000 in savings each year
following. In 2013 the company can recover the cost of the increase in net working capital and
10% of the initial investment cost. The total of these two items equals a cash inflow of $7.2
million in 2013. The sum of the inflows and outflows equal the companys free cash flows from
the project.
Our next step was to use these free cash flows to determine the projects net present
value. To do so we employed Excels NPV function, although we could have calculated it by
hand. Excels function requires the discount rate and the free cash flows. We used our previously
formulated WACC as the discount rate and our cash flows from summing the projects inflows
and outflows. It is also necessary to add the initial investment cost to ensure that your return is
higher than your cost. After doing so, we found an NPV of $2,316,634.72. This figure suggests

the company should accept the project because the NPV is a positive value, meaning the present
value of the benefits outweigh the present value of the costs.
To find the IRR of this project, we simply used the free cash flows we already calculated
and Excels IRR function. IRR does not take the time value of money into account so rather than
needing the discount rate, the only information needed was the cash flows. Using this function
we reached an IRR of 13.28%. This IRR also suggests the company should accept the project
because it is higher than the WACC of 9.67%.
Based on our findings, its clear that Bob Prescott should take on the woodyard project
for the Blue Ridge Mill. With the updated weighted average cost of capital of 9.67% we came to
the conclusion that the NPV of this project is a little over $2,000,000. The internal rate of return
on this project exceeds the discount rate at 13.28%. This analysis proves that the savings on the
costs of the shortwood and the revenues from selling the excess make Worldwide Paper
Company enough money to justify the costs of the woodyard.