Atlantic Corporation – Abridged Case Study Analysis

Incremental cash flows:

Incremental cash flows are generally referred to as additional operating cash flow received by an organization from a new investment or project. As Atlantic Corporation is aiming to acquire the assets of Royal’s Paper;positive incremental cash flow would indicate that the assets should be acquired. For this purpose, the calculation of the incremental sales was based on the assumptions for the years 1994-1998 i.e. Operating profit before depreciation and taxes, depreciation expense, EBIT, Tax at the rate of 36 percent, and working capital of the year 1993 as given in the Exhibit 3 of the case. Thus, the incremental cash flows has demonstrated a decline in 1994 i.e. $89.88 as compared to $92.24,and then a significant increase from the year 1995-1998 i.e. $89.88 for three consecutive years and $138.88 as shown in Appendix A. The reason behind a rapid increase in the incremental cash flow in the year 1988 is because of the recovery of the net working capital the net working capital by the organization, bythe end of the year as per the assumption.

Estimation of Business Risk:

For the estimation of risk regarding the investment in Monticello mill and corrugated box plants, pure play approach was used i.e. the comparison of both the companies. The business risk was calculatedthrough estimating the value of cost of equity and beta value. Thus, the assumption included market risk premium of 7.4 percent and marginal corporate tax rateof around 36 percent.

Atlantic Corporation:

For the estimation of cost of equity for Atlantic Corporation based on assumption, the value of beta and risk free rate of return was considered from the Exhibit 5 of the case i.e. 1.35 and 8.49 percent respectively.Thus, the estimated value of cost of equity was18.48%. Since the cost of equity is higher than the cost of debt i.e. 10.05%. Thus, the organization would have the ability to generate higher rate of return.

Royal Paper:

For the estimation of cost of equity for Atlantic Corporation based on assumption, the value of beta was considered from the Exhibit 6 of the case i.e. 1.25 and risk free rate of return was considered from the Exhibit 5 of the case i.e. 8.49 percent. Thus, the estimated value of cost of equity was 17.7%. Since the cost of equity is higher than the cost of debt i.e. 10%. Thus, the organization would have the ability to generate higher rate of return.

Appropriate Cost of Capital:

For the estimation of appropriate cost of capital to be used in the valuation of linerboard mill and box plants, WACC was calculated for both the organizations. The assumption for the WACC calculation included the market risk premium of7.4 percent.

Atlantic Corporation:

For the estimation of WACC for Atlantic Corporation based on assumption; the value of debt ratiowas considered from Exhibit 1 of the case i.e. 42 percent and cost of debt was considered from the Exhibit 5 of the case i.e. 10.05 percent. Thus, the estimated value of WACC was 11.02%. Since the value of WACC is not higher, which means that the organization has good market value.

Royal Paper:

For the estimation of WACC for Royal Paper based on assumption; the value of debt ratio and cost of debt was considered from the Exhibit 5 of the case i.e. 0 and 10 percent, respectively. Thus, the estimated value of WACC was 13.22%. Since the value of WACC is higher, which means that the organization does not have a good market value as compared to the market value of Atlantic Corporation.

Attractiveness of the linerboard mill and box plants in different scenarios

The analysis for the evaluation of attractiveness of linerboard mill and box plant is performed using sensitivity analysis. Based on the given assumptions, the analysis was divided into three different scenarios. But, before the sensitivity analysis; the enterprise value was $168.18.

Scenario 1:

In Scenario 1, there was a change in the utilization rate i.e. -10%, price per ton i.e. -5%, cash costs – 30%, and Box plant EBTD i.e. -3%. The enterprise value was calculated as ($5.27). The discount rate was 102 percent calculated by subtracting the actual purchase price with the enterprise value and then dividing it by the actual purchase price. Negative enterprise value indicates that the company might have had more cash than required, to pay off its debt.

Scenario 2:

In scenario 2, there was a change in NWC – Net working capital – 5%, Capex – 5%, and terminal growth rate – -0.5%. The enterprise value was calculated as 149.28 and the discount rate of 53%. Comparatively, the enterprise value before the sensitivity analysis is found to be more close to the enterprise value of scenario 2...................................

 

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