Solved Case Study Solution: Worldwide Paper Company By Kenneth M Eades (Download Now)

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Solution Pages: 3

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Questions Covered in the Solution

  • What discount rate should Worldwide Paper Company use to analyze those cash flows? Explain your recommended rate and assumptions that you used to estimate it.
  • What is the net present value and internal rate of return for the investment? How do you interpret these numbers?

Sample of Solution

What discount rate should Worldwide Paper Company use to analyze those cash flows? Explain your recommended rate and assumptions that you used to estimate it.

The discount rate to be used is the latest weighted average cost of capital (WACC) 7.3% calculated based on the market value of debt and equity (Exhibit 1). Latest Treasury rate and that too which corresponds to the project life of 10 years, has been used. In this case, 10-year treasury rate is the best option which stands at 2.04 percent. 10 years ago there was also a chance that the market value of the share could be different, which has an impact on the market capitalization and hence on the debt-to-equity ratio, ultimately affecting the Weighted Average Cost of Capital (WACC). Consequently, we can’t use the previous Cost of Capital, which was calculated 10 years ago in any way.

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What is the net present value and internal rate of return for the investment? How do you interpret these numbers?

The NPV @ 10% hurdle rate is $0.62m which is the past rate based on various estimates that do not reflect the current situation. While the new NPV based on the newly calculated WACC is $2.32m (Exhibit 2). Although this difference does not change the decision to invest in the project. It does give us the assurance that this project has more potential and the chance to give positive cash flows in the future and ultimately giving a positive return on the whole investment. The change in working capital is observed for the first 2 years (2017 and 2018). After that period, there are no changes in the working capital hence this does not affect the cash flows of the company. Sale of working capital is $1m which is realized as 10 percent of the total available working capital.

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