World Paper Company - Finance 18 - Case Study Example

The initial outlay cash flow is the total cost of the investment which is set at $18 million. The initial outlay consists of investment capital, net working costs, set up and transport cost, and training costs. After-tax salvage value of the old assets is subtracted from the initial outlay when making replacement decision (Tham & Pareja, 2004). The annual after-tax cash flows (ATCF) refer to the incremental after-tax cash flows that are expected from the investment. The company’s ATCF cash flows can either fall into these four categories: Tax savings resulting from depreciation (set at 40 percent), incremental income (positive cash flow) (set at 10 percent), incremental expenses (negative cash flow) or savings (positive cash flow), and lost cash flows (negative cash flow) resulting from the existing project activities (set at 15 percent) (Tham & Pareja, 2004).

In investment scenario, lost cash flow is an opportunity cost. Terminal cash flow is the cash flows that are extra ordinary at the end of the project’s life. In the case study, it components will include shut-down costs, estimated salvage value (is set at zero), and recovery of the improved net working capital (is set at 10 percent of the recoverable capital). Reasons: (1) Worldwide Plant Company has not changed its WACC in 10 years. (2) The company has a policy to utilize its corporate Cost of Capital to analyze investment opportunities (Tham & Pareja, 2004).

The Company should invest in the new longwood Woodyard. This is because the outlay capital ($18 million) and the incremental investment in working capital over the next 6 years will be of significant benefit to the