Critical Financial Problems

Q1. What are the benefits and drawbacks, when Bob Prescott considering for
addition of a new on-site Longwood woodyard for Blue Ridge Mill?
According to Bob Prescott, this decision will wipe out the need for purchasing short wood
from outsourcing, which is a necessary item for a paper company. Also, it will enable them
to sell out the extra short wood in the open market, which will provide additional cash flow.
This new woodyard would let them decrease the operating costs and also increase the
revenue from sales. The main source of operating profit will come from the difference of
cost of producing the short hood in own site rather than purchasing from open market.
This new planning would require a massive amount of $18 million of investment,
which will trigger the higher levels of inventories and accounts receivables, which may act as
negative drivers. Bob also didn’t include Inflation in his calculation as he is expecting
inflation in operating costs will be nullified by increase revenue from sales, but this can go
wrong at later stage.

Q2. What are the steps, Bob Prescott considering for addition of a new on-site
Longwood woodyard for Blue Ridge Mill?
 Amount $18 million will spend over two calendar years: $16 million in 2016, $2
million in 2017.
 Estimated opening operating savings would be $2 million for 2017 and $3.5 million
per year after that.
 Estimated total working capital would average 10% of annual revenues.
 After equipment life cycle ended in 2022, all the networking capital on the accounts
would be recoverable at cost.

Q3. Bob Prescott didn’t consider inflation when estimating the cost for a new
on-site Longwood woodyard for Blue Ridge Mill, is it correct estimation?
Bob was pretty much confident about his estimation of revenues and costs for 2016 &
2017 that WPC would most likely to obtain in those years. The capital outlays
traditionally were most thin costs and therefore highly dependable estimation. Bob was
unsure how the operating costs and the price of short wood would be impacted by
inflation after 2017, so he didn’t include the inflation costs not included in his analysis.
Therefore, the dollar estimation for 2018 and next subsequent years was done based on
2017 prices. Another reason for not considering the inflation was he thought the cost
increase because of inflation would be neutralized by increase in revenue due to
inflation.
Q4. Bob Prescott doesn’t want to company defined hurdle rate, is it a correct
decision?
WPC had a company policy to use 10% as the min expected rate of return (Hurdle Rate)
for this kind of investments. This rate based on a survey of the organization’s cost to
capital ten years ago. Bob was uncomfortable to use old data for a discount rate because
it calculated when 30 years treasury bonds were yielding at 4.76%, whereas current rate
is less than 3%.

Q5. What is the planning of Bob Prescott after opening up the new facility for
Longwood?
Bob planned to take advantage of the excess production capacity after the new facility
installed in 2017, by selling short wood on the open market. As soon as the new facility
comes online, he is expecting approximately $4 million in revenue. Estimation short wood
sell revenue should reach $10 million in 2018 and continues to grow. He also estimated the
cost of goods sold (before the depreciation expense) would be 75% of total revenues, and
Selling General and Admin expenses will be 5% of the revenues. The main idea to launch this
new facility came into Bob’s mind from no longer need to use the Shenandoah Mill as a
short hood supplier and that the Blue Ridge Mill would instead compete with the
Shenandoah Mill by selling on the short hood market. The new facility used new technology
that allowed full-length whole tree logs, called Longwood, could be processed directly,
whereas the current way of doing it is purchasing the short hoods from Shenandoah Mill.