International Paper: Longwood Woodyard Plant
15 Pages Posted: 21 Oct 2008
This case and the companion case, International Paper: Alternatives to the Longwood Woodyard Plant (UVA-F-1253), are designed to present the student with the challenge of formulating a discounted cash flow analysis for a capital investment decision. Students are asked to estimate the cost of capital and to conduct a sensitivity of their NPV estimates with respect to inflation, the annual savings figures, and the number of years over which the savings are received. The cases are designed for students who are learning or need a refresher on DCF analysis. Because of the basic issues covered, the cases work well with undergraduate, MBA, and executive education audiences. The cases also afford the opportunity to explore a variety of issues related to capital investment including: manager-owner agency problems, risk adjustment for discount rates, design of a capital budgeting system, the challenges of a cyclical capital intensive industry, and capital structure management
INTERNATIONAL PAPER: LONGWOOD WOODYARD PLANT
In January 1996, Mill Controller Bob Pescod and Mill Analyst Ray Buckley sat down to consider some troubling trends taking place at International Paper's Redding Mill. The Redding Mill produced paper pulp from wood chips using the Kraft process, in which cellulose fiber was extracted from wood using heat and chemicals. Currently, the mill was able to produce about half of its wood chips on-site, with the other half being purchased on the open market. Wood chips were produced by removing the bark from large wood logs and then using a chipper to shred the logs into small pieces. Modern chipping machinery could process tree-length logs, called longwood, whereas the older-style chipping process, such as the one used at Redding, could only process shortwood. Most of Redding's shortwood was produced at the company's nearby Ridgefield woodyard, where longwood was “bucked” to shorter lengths of about five feet, loaded on trucks, and delivered to Redding.
Buckley's analysis showed that, on a delivered basis, the costs of shortwood and open-market chips were rising faster than the cost of longwood. In addition, Buckley pointed out that while Ridgefield could continue to operate, its facilities were outdated and less efficient than newer technology. Regardless of whether Ridgefield would be kept in operation, the cost of shipping shortwood from Ridgefield to Redding was becoming increasingly volatile and difficult to manage.
Pescod and Buckley concluded that considerable cost savings could be realized by replacing Redding's shortwood-processing systems with new longwood-handling equipment, debarking drums, and chippers. The longwood equipment at Redding would increase its chip-production capacity enough so that the mill would rarely need to buy chips on the open market. Furthermore, because Redding would no longer receive shortwood, International Paper would be able to shut down the Ridgefield facility. The cost of shutting down Ridgefield would be offset by the proceeds from selling the replaced shortwood equipment from Redding and Ridgefield plus the recovery of the on-site wood inventories at Ridgefield. Whether the $ 17.7 million new investment in Redding could be justified by the expected operating savings, however, would have to be carefully documented before the project would receive approval from the Board of Directors.
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Keywords: discounted cash flow, capital budgeting, capital investment, internal rate of return, net present value
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