Worldwide Paper Co |
Bob Prescott was considering the purchase of a new machine for WPC that would make it easier to process longwoods. He hoped the purchase would allow WPC to no longer buy shortwood from other mills and allow them to sell excess shortwood on the open market. This would help WPC to reduce operating costs and increase revenues. The total cost for the new technology was $18 million and Prescott wanted to know if this would be a sound investment.
The first step in helping Prescott was to calculate a new cost of capital—as the one used by WPC was 10 years old. I used the weighted average cost of capital equation to calculate a new WACC of 9.97%. My calculations are and assumptions are shown in further detail in the attached sheets.
Next, I had to generate the free cash flows for years 2007-2013 using Prescott’s given assumptions.
* $18 M purchase price
* $1.8 M selling price
* Investment in PPE (2007) was $16 M
* Investment in PPE (2008) was $2 M
* $4 M in Sales (2008)
* $10 M in Sales (2009-2013)
* COGS: 75% of Sales
* SG&A: 5% of Sales
* $2 M Operating Savings (2008)
* $3.5 M Operating Savings (2009-2013)
* Depreciation was on a straight-line basis for 6 years beginning in 2008
* $18 M / 6 years = $3 M
* 40% tax rate
* NWC: 10% of Sales
* Salvage value was zero
* The FCF per year was determined using the following:
* Net Income + Depreciation Expense - ∆ Net Working Capital + Investment in PPE
After generating the FCF for each year, I had to solve for NPV and IRR to value the investment. I calculated 2 NPVs—one using Excel’s NPV equation and the other by discounting each year’s FCF using the WACC I calculated earlier. Both methods gave me negative NPVs.
* Excel NPV: ($489,344.33)
* Discounted FCF NPV: ($538,153.89)
Lastly, I used Excel to calculate the IRR—8.99%.
The negative NPVs indicate that the project will not add value to the firm. In...