Jimmy McGill and the Longwood Yard
                                 

In January 2018, Jimmy McGill, the Manager for the Longwood Yard (A lumber mill), was 
considering the addition of a new on-site longwood woodyard. The addition would have 
two primary benefits: to eliminate the need to purchase shortwood from an outside 
supplier and create the opportunity to sell shortwood on the open market as a new 
market for Yellow Wood Paper Company (YWPC). The new woodyard would allow the Longwood 
Yard not only to reduce its operating costs but also to increase its revenues. The 
proposed woodyard utilized new technology that allowed tree-length logs, called longwood, 
to be processed directly, whereas the current process required shortwood, which had to 
be purchased from the Wabash Mill. This nearby mill, owned by a competitor, had excess 
capacity that allowed it to produce more shortwood than it needed for its own pulp 
production. The excess was sold to several different mills, including the Longwood 
Yard. Thus adding the new longwood equipment would mean that McGill would no longer 
need to use the Wabash Mill as a shortwood supplier and that the Longwood Yard would 
instead compete with the Wabash Mill by selling on the shortwood market. The question 
for McGill was whether these expected benefits were enough to justify the $18 million 
capital outlay plus the incremental investment in working capital over the six-year 
life of the investment. Construction would start within a few months, and the investment 
outlay would be spent over two calendar years: $16 million in 2018 and the remaining 
$2 million in 2019. When the new woodyard began operating in 2020, it would significantly 
reduce the operating costs of the mill. These operating savings would come mostly from the 
difference in the cost of producing shortwood on-site versus buying it on the open market 
and were estimated to be $2.0 million for 2020 and $3.5 million per year thereafter. 
McGill also planned on taking advantage of the excess production capacity afforded by 
the new facility by selling shortwood on the open market as soon as possible. For 2020, 
he expected to show revenues of approximately $4 million, as the facility came on-line 
and began to break into the new market. He expected shortwood sales to reach $10 million 
in 2021 and continue at the $10 million level through the end of the project. Jimmy is 
very concerned about the required EPA audit before starting the project that will cost 
$1 million. He wants to include this cost in the analysis. 
McGill estimated that the cost of goods sold (before including depreciation expenses) 
would be 75% of revenues, and SG&A would be 5% of revenues. In addition to the capital 
outlay of $18 million, the increased revenues would necessitate higher levels of inventories 
and accounts receivable. The total working capital would average 10% of annual revenues. T
herefore the amount of working capital 
investment each year would equal 10% of incremental sales for the year. At the end of the 
life of the equipment, all the net working capital on the books would be recoverable at cost 
(Meaning the company recovers all paid net working capital at time zero), whereas only $1.8 
million (before taxes) of the capital investment would be recoverable. Taxes would be paid at 
a 40% rate, and depreciation was calculated on a straightline basis over the six-year life,
 with zero salvage (straightline means each year the company depreciates 1/6 of the total value). 
 The capital outlays were mostly contracted costs and therefore were highly reliable estimates. 
 The expected shortwood revenue figure of $4.0 million had been based on a careful analysis of 
 the shortwood market that included a conservative estimate of the Longwood Yard's share of the 
 market plus the expected market price of shortwood, taking into account the impact of Longwood 
 Yard as a new competitor in the market. YWPC had a company policy to use 15% as the hurdle rate 
 for such investment opportunities. The hurdle rate was based on a study of the 
Solve Free Cash Flows Using FCF = EBIT(1-T) + DEP - CAPEX - (cb)NOWC WACC =5.616%