Case Study: Knight

International
Group Members:
Ali Nawaz
Amir Wazir
Shahzeb Ahmed
Huma Ijaz
Sidra Arshad
Zahra Ali

Introduction
Knight International
largest producers of paper & pulp
believes in community work & CSR

Top management reluctant to decentralize the decision making

power
Andy Kurzer- chairman made 6-person Expenditure Committee
who would decide on projects costing more than 2 million

Main issue weather to renovate the old production facility or to

build a new one
Reason exiting production facility will reduce its capacity
significantly in the coming years.
The initial controversy
management of old facility
EC member pointed 20 years was longer time for a modernized old
facility

Given Data

EXHIBIT 2
Information on Renovation and New Facility

Project 1
Project 2

New Facility
(Original) Old
Facility
After-tax cost ($)A
680,000,000
170,000,000
Tax rate (%)
40
40
Project Length (Years)
20
20
Price per ton ($)
500
500
Tonnage per day B
2,200
1,600
Variable cost per ton ($)
250
290
Fixed operating cost per
57,360,000
21,824,000
year ($)C
Fixed operating cost per
72.42
37.89
ton ($)C
Depreciation Method
SL
SL
Depreciation life (years)
20
20
Depreciation per year ($) 34,000,000
8,500,000
Depreciation per ton ($)
42.93
14.76
After-tax cash flow ($)
118,384,000
67,981,600
Required Return
12%
12%
Days
360
360

Project 3
(Revised) Old
Facility
170,000,000
40
20
500
1,200
310
21,824,000
50.52
SL
20
8,500,000
19.68
44,653,600
12%
360

Income statement for Project 1- New

Facility
Sales

396000000

=Price per ton *Tonnage per

day*days

Cost Of
Production
Variable Cost

198000000

=Tonnage per day*Variable cost

per ton*days
=Sales-VC

Gross Profit
Expenses
Fixed Expenses
Operational
Cost without
Depreciation
Other Expenses
Depreciation
Total Expenses

198000000

EBIT
Tax
Net Income

140,640,000
56256000
84,384,000

23,360,000

34,000,000
57,360,000

=Fixed operating cost per year

-Depreciation

given
Operational Cost without Dep+
Dep
Gross Profit-Total expenses
EBIT*40%
EBIT-Tax

Income Statement for (Revised) Old Facility

Sales
Cost Of Production
Variable Cost
Gross Profit
Expenses
Fixed Expenses
Operational Cost
without Dep
Other Expenses
Depreciation
Total Expenses
EBIT
Tax
Net Income

21600000 =Price per ton *Tonnage per

0
day*days

133920000 =Tonnage per day*Variable cost

per ton*days
82080000 =Sales-VC

13,324,000 =Fixed operating cost per year

-Depreciation

8,500,000 given
21,824,000 Operational Cost without Dep+
Dep
60,256,000 Gross Profit-Total expenses
24102400 EBIT*40%
36,153,600 EBIT-Tax

Question No. 1

Calculate the NPV of modernizing the existing paper

Initial investment
-170,000,000
mill.
Operating Cash Flow (each
year)
Total Cash Inflow
PVCF at 12%
NPV
(PVCF-initial
investment)

44,653,600

$893,072,000.00
$333,537,548
$163,537,548

Calculate the NPV of building a new paper mill.

Initial investment
Operating Cash Flow (each
year)
Total Cash Inflow
PVCF at 12%
NPV
(PVCF-initial
investment)

-680,000,000
118,384,000

$2,367,680,000
$884,262,614
$204,262,614

Note: Operating cash flow is same for 20 years as

growth rate and/or inflation rate is not given in data

Question No. 2
Calculate the IRR of each investment

Existing paper mill 26.009%

New paper mill 16.603%

Calculate the payback of each

Existing paper mill 3.81 ~ 4 Years

New paper mill 5.74 ~ 6 Years

Question No. 3
Do the NPV and IRR methods give the same
accept/ reject signals?
They are mutually co related because
1.
2.

NPV is Positive
IRR is greater then 12%

Question No. 3
.

Explain why the NPV and IRR methods can give divergent signals when evaluating mutually exclusive alternatives

NPV= market valuecost

+NPV adds value to
the facility & increase
owner wealth

For IRR
New Facility 16.603%
Revised
Facility26.009%

NPV is + but IRR

is less than
discount rate

Question No. 4

Suppose that the appropriate life of a

modernized factory is 15 instead of 20
years.
Evaluate the argument that assuming a
20-year horizon for this project adds
$44,653,600 times 5 or $223,268,000 to
Cash cash
flow for
20 $893,072,000
the yearly
flows.
Years
Cash flow for 15
Years
Difference

$669,804,000
$223,268,000

Questions No. 5
Based on your calculations in the previous questions
and information in the case, what decision do you
recommend? Justify your answer.
Project A
NPV positive with higher value
IRR greater than 12%

Question No. 6

(a)Building a new mill requires $510 million

more than modernizing the old mill but will
generate an extra $73,730,400 in yearly cash
flow.
Calculate the IRR on this incremental
expenditure. Compare your answer to the 12
percent required return.
(b) Based on your answer in part (a), suggest a
decision rule for the IRR in evaluating mutually
exclusive alternatives with different initial
costs.
Incremental IRR 13.26%

Question No.7

Use the information in Exhibit 2 to explain

how the yearly cash flow estimate was
obtained for:
Operating Cash
NI + Depreciation
Modernizing
the Flow=
old mill.
NI

36,153,600

Depreciation
1-20 years

8,500,000
44,653,600

Operating
Cashmill.
Flow= NI + Depreciation
Building
a new

NI

84,384,000

Depreciation

34,000,000

1-20 years

118,384,000

Note: Scrap value for both the projects is zero

Question No. 8

Suppose depreciation is over 5 years instead of 20

years
Existingthe
Paper
Mill and IRR of each project be
How would
NPV
Initial investment
170,000,000
affected?
Operating Cash Flow (each
year)
44,653,600
Total Cash Inflow (for 5 years) $350,768,000
Scrap Value
127,500,000
PVCF at 12%
$225,561,703
NPV (PVCF-initial investment) $55,561,703
IRR
21.266%
New Paper Mill
Initial investment
Operating Cash Flow (each
year)
Total Cash Inflow (for 5 years)
Scrap Value
PVCF at 12%
NPV (PVCF-initial investment)
IRR

680,000,000
118,384,000
$591,920,000
510,000,000
$685,129,698
$5,129,698
12.211%

Question No. 8
Which of these two projects will have the larger NPV change?
Why?

Existing paper mill

NPV (20
New paper mill
years)=163,537,548
NPV (20
NPV (5 years) =
years)=204,262,614
55,561,703
NPV (5 years)=5,129,698
Difference=107,975,84
Difference=199,13
5
1. Cash flow return of new paper mill is higher
2,916
2. As NPV of 5 years is low so the difference is greate

Question No. 9

How low can average annual production

go before each proposal is unexpected?

Tonnage per day B

New Facility

(Revised) Old Facility

1,694

667

Question No. 10

Is it appropriate to use the same discount rate to

evaluate both proposals?
For like comparison we have to use the same discount rate
The starting period for both the projects is same

How, if at all, does your answer to 10 (a) affect your

choice in question 5?
No we would not change our decision