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Advanced Issues in Corporate Finance
S20
Company Background
December 2016, Lucy Lang, the controller for the Blue Ridge Mill, was considering the addition
of a new on-site long lumber yard. The addition would have two primary benefits: to eliminate the
need to purchase long-lumber from an outsider supplier and create the opportunity to sell long-
lumber on the open market as a new market entry for Worldwide Paper Company (WPC).
The construction of the new yard would start within a few months and the investment outlay would
be spent over two calendar years: $16 million in 2017 and the remaining $2 million in 2018.
The proposed new yard would allow Blue Ridge Mill not only to reduce its operating costs but
also increase its revenues. When the new yard begins operating in 2018, it would significantly
reduce the operating costs of the mill. These operating savings would come mostly from
the difference in the cost of procuring long-lumber on-site versus buying it on the open market and
were estimated to be $2.0 million for 2018 and $3.5 million per year thereafter.
Lang also planned on taking advantage of the excess production capacity afforded by the new
facility by selling long lumber on the open market as soon as possible. For 2018, she expected to
show revenues of approximately $4 million, as the facility came on-line and began to break into
the new market.
She expected long-lumber sales to reach $10 million in 2019 and continue at the $10 million level
through 2023. Lang 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 receivables. 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 2023, all the networking capital on the books would be
recoverable at cost, whereas only 10% or $1.8 million (before taxes) of the capital investment
would be recoverable.
Primary Benefits of New Yard
Eliminates the need to purchase long lumber from an outside supplier (Shenandoah Mill)
Creates the opportunity to sell longer lumber on the open market as a new market
Reduces operating cost and increases revenue
Problem Identification
Whether the expected benefits were enough to justify the $18 million capital outlay plus the
incremental investment in working capital over the six-year life of the investment?
Corporate bonds (10-year maturities):
1-year 4.96% Aaa 5.37%
5-year 4.57% Aa 5.53%
10-year 4.60% A 5.80%
Baa 6.25%
Balance sheet accounts ($ millions):
Current long-term debt 500
Long-term debt 2,500
Common equity 500
Retained earnings 2,000
Per share data:
Shares outstanding (millions) 500
Book value per share $5.00
Recent market value per share $24.00
Other financial information:
Bond rating: A
Beta: 1.10
Tax rate: 40%
Market premium: 6.0%
Global Paper Financial Information:
Government bonds:
Interest rates: December 2016