The boxes market scenario in the year 1984 projected an increase in demand of the linerboard and boxes. Thus the limited number of linerboard mills and high level of fixed costs in the linerboard industry ensured high profits for the linerboard industry.
- What basis, if any, is there for expecting Atlantic Royal’s combined linerboard and box mill operation to do better / worse than the industry overall?
Ans3. Atlantic Corporation is classified as one the nation’s largest “forest products” firm which responded pretty quickly to changes in the overall economy mainly the interest rate fluctuations. On the contrary, linerboard industry’s performance is also tied to that of economy but less directly to economic shifts; and Atlantic Corp. also had its operations in this industry but not quite dominating and strong. Hence, if Atlantic Corp. is able to take over the Royal Board’s Monticello paper mill, it will increase it linerboard capacity which would turn out to be lucrative for the firm since it was expected that 1984 would be a healthy year for the linerboard industry where in the industry would operate at nearly 100% utilization because of the strong demand and limited supply. The linerboard and box sales were predicted to rise 7% as real GNP and consequently industrial production was strengthening with this prediction.
The existing linerboard mill of Atlantic produced 780 tons per day of linerboard that represented only 1.8% of domestic capacity and also Atlantic was the only major paper producer that was a net buyer of linerboard. In a market which was too tight, linerboard could become unavailable or extremely expensive, and in such a scenario it was required by Atlantic to remedy its linerboard shortage else the raw material prices could mitigate its box division’s profits. And Monticello being the fourth best paper mill in the country could help Atlantic greatly in boosting its linerboard capacity and subsequent market performance. The industry then seemed to be fraught with the dearth of sufficient linerboard production. And Royal paper’s profit then had been growing consistently and the conversion of Monticello to 100% linerboard production bettered its prospects. Royal’s chairman had announced a master plan to modernize the Monticello Mill which would increase its linerboard capacity from 661,000 tons per annum to 747,000 tons per year. In such a situation, if Atlantic could buy Monticello and 16 box plants(located all over US when combined Royal’s box plants), the chances become high that it could do better than the industry average by strengthening its linerboard production and marking its presence in most major US markets.
- What prices should Atlantic Corp be willing for the linerboard and box mill operations of Royal Paper Corp? What value, if any, should be assigned to the years after 1993? [Apply a DCF/WACC approach]
Ans4.
The price that Atlantic Corp will be willing to pay for Royal Monticello Mill and box mills can be valuated as follows:
Free cash flow derivation:
Thus, Atlantic Corporation would be willing to pay $377.8 MM to buy Monticello Mill and box plants.
In general, a 2000 ton-per-day linerboard mill has an economic life of 30 years. Current year is 1984. Currently the Monticello mill has a 15 year economic life; its salvage value will be negligible after the year 1998. After the year 1993, more than half of the economic value of the company would have been depreciated. Therefore the value of the mill would be reduced by approximately 60%.
- Would you acquire Royal’s linerboard and box will operations? What price would you pay?
Ans5. From the Atlantic Corporation’s view, Royal’s linerboard and mill operation is a reasonable and justifiable investment and they should go ahead with the acquisition. The calculations we made are based on cash flows of Royal alone and do not include the synergy effect that will exist after the acquisition. Therefore, we conclude that it would be conservative to pay anything less than $377.8 million. If Atlantic pays more than $377.8 MM, then more detailed calculations have to be made based on future economic projections and predictions with respect to the growth rate and other financial parameters as well as considering the synergy effect between the two companies. Thus, it would be wise to say that it would be wise enough to buy Royal’s Monticello Mill and 16 box plants for the calculated price.
- Assuming that Atlantic does require Royal Paper’s mill and plant for $319 million what would be the magnitude of Atlantic’s external funding needs over the next 4 years, and what would be the most appropriate means of financing those needs?
Answer 6. The magnitude of the Atlantic’s external funding needed over the next 4 years can be calculated as follows:
As shown above there is a requirement of $329 million. We propose that Atlantic raise this money by:
- Drawing on Bank line of credit of $200 million bearing interest at prime rate plus 1.5% which would be 10.75% with then prime rate of 9.25%.
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Issuing debenture of worth $129 million at a yield of 10.25% and with the interest payments starting from the 6th year.
The given would be the most appropriate means of financing the needs. With the risk of being taken over in a hostile environment, Atlantic’s Halloran had to come up with something that would assure the support of the stockholders while also protecting Atlantic’s bond rating. Further declines in the bond yields were anticipated and stock market did not seem to move on a higher strength in future. Because of these volatile markets, it would be a good idea for Atlantic to go for the above financing structure as it wouldn’t lead to dilution of Atlantic’s earnings per share by issuing common stock in unstable and weak stock markets and thus safeguard the shareholder’s interests.
