International Paper: Longwood Woodyard Plant

Lecturer:

Dr. Ismail Abd Rahman

Prepared by:

Hamed Arjmandi

MR111051

17/03/2012

This case was about International Paper’s Ridding Mill which was the largest paper- and forest –

Products Company in the world in 1995. This company produces different type of products in 31

countries. The Redding Mill produced paper pulp from wood chips. So, to supply all wood needed for

this process they produced about half of its wood on-site and purchased another half from open market.

To produce wood chips from wood logs they used chipper to shred. For doing this process there were

two way: 1. Using modern chipping machinery that called longwood 2. Using old style chipping

process, used at Redding, which called shortwood. Most of Redding’s shortwood was produced at the

Regefield woodyard that located one mile from Redding. . In 1996, controller Bob Pescod and analyst

expert Ray Buckley check some troubling trends taking place at Redding Mill.

1. The cost of shortwood & open market chips were rising faster

than the cost of long wood

Buckley’s analysis showed: 2. Ridgefield facilities were outdated & less efficient

3. The cost of shipping shortwood was becoming increasingly

volatile and difficult to manage

1. Considerable cost savings could be realized by replacing

Pescod & Buckley concluded: Shortwood process system with longwood process

2. The cost of shutting down Ridgefield would be offset by:

the proceeds from selling the replaced shortwood equipment +

recovery of the on-site wood inventories at Ridgefield

According to Exhibit 1:

Net sale: (1994) $ 14.96 billion (1995) $19.79 billion

Operating profit: (1994) $ 1.06 billion (1995) $2.52 billion

Net income: (1994) $ 0.35 billion (1995) $1.15 billion

Total asset: (1995) $ 24 billion

Security analyst asked from industry, by increased dividend or through stock- buyback programs return

cash flow to investors and cut capital spending.

In 1995:

IP’s capital spending ($ 1.52 billion) = depreciation & amortization ($ 1.03 billion) + nondiscretionary

spending (approximately $ 0.5 billion)

The treasurer stated that keeping the A rate bye decrease the amount of debt-to-capital. It was very

important because it gave the company enough financial flexibility to react to unexpected investment

opportunities in the future.

The Capital- Budgeting Process:

Due to capacity expansion company’s operating unit should prepare a facility plan yearly. They started

32%

136%

223%

To make the wish lists then after reviewing facility plans and related strategic plans, the management

would indicate an approximate level of capital spending for the annual budget. The funds were

allocated based on each business’s unit needs.

Individual projects were still required to go through a capital- approval process. Project’s viability was

measured by hurdle rate. Increasing the company’s overall return on investment was the objective that

should be met by discretionary spending and restrict the amount of capital requests. The 15 percent of

hurdle rate had the advantage of being easier to understand than a cost of capital that changes whenever

interest rates or company’s specific risk changed. (Hurdle rate: the minimum rate of return on a project

or investment required by management or investor)

(Return on Investment= (gain from investment – cost of investment) / cost of investment)

In December, Board of Directors make a decision about capital budget, Also an appropriate

management level approved individual project. At facility level, small projects were developed and

managed. Technology group designed and engineered larger projects.

The Forest-Product Industry

From 1990 to mid-1994, the pulp prices decrease more than 50 percent, but in the mid- 1994 the

industry regain pricing power. After restructuring in the forest- products industry, they appointed new

CEO in 1993 and 1994 with the goal of creating shareholder value. International Paper hade come

through the early 1990’s relatively intact, with the same CEO and with a respectable 10.95 percent

compound annual growth rate in share price for the years 1990-96.

New Longwood- Processing System at the Redding Mill:

The Redding Mill Woodyard currently:

On-site storage capacity = 30,000 tons (23,000 tons shortwood storage + 5,000 tons chips purchased +

2,000 tons chip storage in the four chip silos) (9days)

Two off-site storage capacity = 80,000 tons (25days)

The new on-site longwood woodyard:

On-site storage capacity = 32,000 tons (25,000 tons longwood storage + 5,000 tons existing purchased

– chip storage) (10days)

Two off-site storage capacity = 80,000 tons (25days)

Shutting down Ridgefield would allow IP to eliminate 3 days of storage kept at the Ridgefield facility.

Analysis:

During two years, cost of the new system should be incurred:

Market value of the extra chip storage at Ridding in 1998: $ 800,000

Labor saving in 1998: $ 3.3 million

Reduction transportation and handling cost in 1998: $ 1.5 million

The only offset to these savings was the MPA costs which were expected to run $ 380,000 in 1998

$ 17.7

million

$ 9.7 million

1996

$ 8.0 million

1997

Apart from the cost consequences, the new longwood facility bring new opportunity: $ 1.5 million

starting in 1997

Final Consideration:

According to Exhibit 5: ∑

( ) ( )

So the renovation of Ridgefield is not a valuable scenario for the Board of Directors