Is Wansley Lumber Should Purchase the Paper Company?

Analysis of Wansley Lumber's Decision

Wansley Lumber is considering the purchase of a paper company that would require an initial investment of $300 million. The paper company is estimated to provide net cash flows of $40 million at the end of each year for the next 20 years. The cost of capital for the paper company is 13%.

The decision of whether Wansley should purchase the paper company can be analyzed by calculating the net present value (NPV) of the investment. NPV helps in determining whether an investment is expected to increase the value of the company or not.

Calculation of Net Present Value (NPV):

The formula to calculate NPV is as follows:

NPV = Present value of all annual cash inflows after implementation of discount factor - Initial investment

Given data:

Initial investment = $300 million

Annual net cash flows = $40 million

Cost of capital = 13%

Number of years = 20

Using the formula to calculate the present value of cash flows, we get:

Present value of cash flows = Annual net cash flows × PVIFA for 20 years at 13%

Present value of cash flows = $40 million × 7.0248

Present value of cash flows = $280.992 million

Therefore, the net present value would be:

NPV = $280.992 million - $300 million

NPV = -$19.008 million

Since the NPV is negative, it indicates that the present value of cash inflows is less than the initial investment. This means that the investment in the paper company would not increase the value of Wansley Lumber. Therefore, Wansley should not purchase the paper company based on the calculation of NPV.