Fort Green World

CASE STUDY OVERVIEW

Fort Green World is the largest producer of paper and pulp
First plant in rural area of new England
Kurzer formed companys capital budgeting procedures to
decide projects of more than $200,000
Existing mill at Lees Point, North Carolina
Production to drop to 600 tons with yearly cash flow of
$11,422,320
Project of new mill at MidTown 15 miles away from Lees
point

 New mill investment $618.8 million with yearly Cash

flow of $107,728,000
Modernization mill investment 154.7 million with yearly
cash flow of $40,634,680
Old projection of $ 61,863,160with variable cost of
$263.9/ton(existing)
Modernized plant to operate not more than 15 years
New plant to affect employee moral and loyalty

Questions

Q1 :NPV of New Projects

Modernized mill:
Investment = $154,700,000
I = 12%
Yearly cash flow after tax deduction = $40,634,680 (for
20 years)
Incremental cash flow= $ 40,634,680- $ 11,422,320 =
$29,212,360
NPV= $ 63,500,076.15

New Mill
Investment = $618,800,000
I%= 12%
Yearly cash flow after tax deduction = $107,728,000 ( for
20 years)
Incremental cash flow =$107,728,000 - $ 11,422,320 = $
96,305,680
NPV =$ 100,549,850
Decision: NPV supports new mill project with higher
positive NPV.

Modernized Mill NPV With Actual Cash Flows

Investment = $154,700,000
Required rate of return = 12%
Yearly cash flow after tax deduction = $40,634,680 (for 20
years)
NPV = $148,818,451.5

New Mill NPV with Actual Cash Flows

Investment required for the modernization = $618,800,000
Required rate of return = 12%
Yearly cash flow = $107,728,000
NPV = $185,868,222.8

Q2: IRR and Payback

(A) Calculation of IRR of each investment :
()IRR of Modernization of existing mill :
IRR = 18.219%
()IRR of new paper mill:
IRR = 14.531%
(o)Modernization of the existing paper has a higher IRR .

(B) Calculation of the payback period of each investment:

Payback period of Modernization of existing mill :
Initial investment / annual cash flows
= 3.807 years
Payback period of new paper mill:
Initial investment / annual cash flows
= 5.744 years
o The investment made in the modernization of existing paper mill will

be recovered earlier then the investment in the new paper mill.

Q3: NPV and IRR methods

A) NPV and IRR methods give the same accept /
reject signals:
o No
o NPV accepts the investment in building a new paper mill
o IRR method accepts the investment in the modernization
of the existing paper mill.

B) NPV and IRR methods can give divergent signals

when evaluating mutually exclusive alternatives:

In mutually exclusive projects, all projects serve the same purpose

Such projects cannot be undertaken simultaneously.
Only one project can be accepted and the others are to be
rejected.
The cash flows of one project can actually be adversely affected
by the acceptance of the other project.
The investment scale of both projects is different
The cash flow of building a new paper mill is $67,093,320 more
than the cash flow of the modernization of existing paper mill.

Q 4: Life of Modernized
Mill 15 years
Investment = $154,700,000
I%= 12%
Yearly cash flow after tax deduction = $40,634,680 (for
15 years)
NPV= $ 122,057,300
IRR = 25.384%

With Incremental Cash

Flows
Incremental cash flow=$ 29,212,360
NPV= $ 44,261,425.38
IRR= 17.118%

IRR decreased by only 1.1%

NPV decreases by only $ 19,238,650.77
showing less effect of later cash flows then early cash flows
Choosing modernization of paper mill
lower payback
Better IRR
15 miles away only

Continued
Evaluation:
He wants to say that yearly cash flow is $40,634,680
It adds 203,173,400 to total yearly cash flows in 5 years
that is actually a large amount
Others consider 20 years a long period.
The later cash flow add very low amount to NPV
Not having more affect on IRR and not affecting
decision.

Q5 :
Question 5
If we compare the IRR still the modernized facility has a
better IRR (18.219%) then New mill project (14.531%)
and a better payback.
Time period if is 15 years for modernized mill than also
IRR is 17.118%.
It is only 15 miles away.
Employee loyalty can be affected with new mill
construction due to higher distance.

Q6 : IRR With Incremental Expenditure

(A):
IRR = 13.258% of incremental expenditure
o 13.258% is the crossover rate of both the projects where there
NPV = $126,379,470.
o If we compare this rate to the required return 12% we will accept the
project.
o If the cash flows have been overestimated this may be causing the
result of IRR to be 13.248% that is only 1.25% more than required
return may be the actual cash flows are lower which may lower the
IRR to 12% or even lower than that that can actually make the
project unacceptable.

B: IRR Rule
o The decision rule for IRR in case of mutually exclusive
alternatives, accept a project with IRR greater than cost
of capital
o If both the projects have IRR greater than their cost of
capital, select the project having the highest IRR.
o Divergent signals by IRR and NPV
o For independent projects, IRR and NPV would have
given same answers.

Q7 : Data required for calculating the yearly

cash flow

Income statement for calculation of the operating

cash flow:
Modernizing existing

Building new building

facility
Sales

455 x1200 x360=

455 x2200 x360=

(Price per ton x number of

$196,560,000

$360,360,000

($19,860,000)

($52,200,000)

tons x no. of days in a year)

Less: Fixed cost per year

(includes depreciation)

Less: variable cost per year 282.1 x 1200 x 360=

($121,867,200)

227.5 x 2200 x 360=

($180,180,000)

EBT

$54,832,800

$ 127,980,000

Less: 40% tax

($ 21,933,120)

($ 51,192,000)

Net income

$ 32,899,680

$ 76,788,000

Add Depreciation

$ 7,735,000

$ 30,940,000

Net operating cash flow

$ 40,634,680

$ 107,728,000

Q8 : Depreciation over 5
years (For first five years)
Modernization the old mill

Sales

Building a new mill

$196,560,000

$360,360,000

(12,125,000)

(21,260,000)

(121,867,200)

(180,180,000)

(30,940,000)

(123,760,000)

31,627,800

35,160,000

(12,651,120)

(14,064,000)

Free Cash Flow

18976680

21096000

Add: Dep

30940000

123760000

49,916,680

144,856,000

Less: F.C.(dep not included)

Less: VC
Dep

(SL5

years)=initial

investment/5
EBT
Less: tax

Net Cash Flow

For next 15 years

Modernization the old mill Building a new mill
Sales
Less:

F.C.(dep

included)
Less: VC
EBT
Less: tax
Net Cash Flow

not

196560000

360360000

(12,125,000)

(21,260,000)

(121,867,200)

(180,180,000)

62567800

158920000

(25,027,120)

(63,568,000)

37,540,680

95,352,000

Using financial calculator

change in NPV
Q8 (b)

Modernization the old Building a new mill

mill

NPV (dep for 20 years)

$ 148,818,451.5

$ 185,868,222.8

NPV (dep for 5 years)

$ 170,320,703.2

$ 271,877,229.6

NPV change

$ 21,502,251.7

$ 86,009,006.8

14.45%

46.32%

NPV change %

NPV change with

Incremental Cash Flows
Modernized mill

New mill

$ 63,500,076.15

$ 100,549,850

$ 85,002,327.86

$ 186,558,850

18.219%

14.531%

21.5224%

17.4369%

Change in NPV

$ 21,502,251.71

$ 86,009,000

Change in IRR

3.3034%

2.9059%

NPV change in %

33.86%

85.54%

NPV of project with 20

year depreciation
NPV of project with 5
year depreciation
IRR of project with 20
year depreciation
IRR of project with 5
year depreciation

 REASONS
The NPV change would be higher in building a new mill
Possible reasons would be the magnitude of early and
latter cash flows
Latter cash flows experience greater impact of discount
rate rather early cash flows
5 year depreciation makes early cash flows higher.

Q9 how low annual

production can go
A. Yearly cash flow of modernized mill
. R= 12%
. n= 20
. PV= $154,700,000
. PMT = $ 20711047.27

B. Yearly cash flow of new mill

. R= 12%
. n= 20
. PV= $618,800,000
. PMT = $ 82,844,189.09

Minimum annual production

Modernization of

Building New Mill

existing mill
Operating cash flow

$ 20,711,047.27

$ 82,844,189.09

Less: depreciation

($7,735,000)

($30,940,000)

Net Income

12,976,047.27

51,904,189.09

EBT

$ 21626745.45

$ 86506981.82

Add Fixed Cost

$ 19,860,000

$ 52, 200,000

Gross profit

$ 41486745.45

$ 138706981.8

Tonnage per year

239,946.47455

609701.019

Add Variable Cost =

$ 67688900.47

$ 138706981.8

$ 109175645.9

$ 277413963.6

tonnage per year x

variable cost per ton
Sales

Question 10
Same discount rate to evaluate project

Own cost
Cost of capital
Risk( higher for higher return)
Higher discount rate : lower NPV
Every projects IRR should be compared with its own cost
of capital

Q10 Continued
Affect decision in 5
Decisions are affected if the IRR are compared with each
projects cost of capital
Thus, it is actually better to use NPV rue if IRR is higher
of both projects
Change of decision in question 5 of modernized mill
project

Thank You