Microsoft Word - Pacific Container Corp (2021)
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Pacific Container Corporation: Some
Financial Concerns
On January 5, 2021, his first day as chief executive officer (CEO) of Pacific Container
Corp. (PCC), Chris Chen confronted a host of management problems at the company.
One week earlier, PCC’s president and CEO had a
uptly resigned to take a CEO position
at another company. Soon thereafter, Chris was appointed to fill the position – starting
immediately. Several issues in his in-box that first day were financial in nature, either
equiring a financial decision, or with outcomes that would have major financial
implications for the firm. That evening, Mr. Chen asked to meet with his assistant, Mark
Tan, to begin addressing the most prominent issues.
PACIFIC CONTAINER CORPORATION AND THE CARDBOARD BOX AND
CONTAINER MANUFACTURING INDUSTRY
The Pacific Container Corporation had been founded as a joint venture between Carolina
Pulp & Paper and an Asian venture-capital firm, New Era Partners. Based in Singapore,
PCC’s sole business mission was to manufacture boxes from cardboard packaging known
as co
ugated Fibe
oard. PCC served as a supplier of cardboard boxes to other
manufacturing firms in the Pacific Rim and was known for producing some of the best
cardboard packaging material in the industry.
Given its ubiquity in packaging, revenue for the global cardboard box and container
manufacturing industry is highly co
elated with global demand from manufacturing and
etail sectors. The industry is highly fragmented with an estimated 15,700 companies
operating in the industry (globally) and only 4 companies controlling more than 1.0% of
the market. The majority of companies operate locally or regionally, providing cardboard
oxes to companies within a relatively short distance from their facilities. Ba
iers to
entry are relatively low; a new, small plant would cost between SGD1 10 million and
SGD 20 million. Easy entry had led to price competition in recent years among cardboard
ox manufacturers. One analyst said,
The gross margins on cardboard boxes have eroded tremendously over the past
five years. I don’t see there’s any more maneuvering left on the price.
Despite increasingly intense competition for cardboard packaging material, PCC’s growth
prospects looked
ight. At the regional level, demand was strong and PCC’s focus on
customer service and quality products had resulted in a strong and expanding customer
ase.
1 SGD = Singaporean dollars
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FINANCIAL QUESTIONS FACING VICTORIA YU
That evening, Mr. Chen met with Mark Tan, a promising new associate whom he had
ought along from New Era. Mr. Chen’s
ief discussion with Mark went as follows:
Mr. Chen:
Back at New Era, we looked at PCC as one of our most promising venture-capital
investments. Now it seems that such optimism may not be wa
anted – at least until we
get a solid understanding of the firm’s past performance and its forecasted performance.
Did you have any success on this?
Mark:
Yes, the bookkeeper gave me these: the historical income statements [Exhibit 1] and
alance sheets [Exhibit 2] for the last four years. The accounting system here is still
pretty primitive. However, I checked a number of the accounts, and they look orderly. So
I suspect that we can work with these figures. From these statements, I calculated a set of
diagnostic ratios [Exhibit 3].
Mr. Chen:
I see you have been busy. Unfortunately, I can’t study these right now. I need you to
eview the historical performance of PCC for me, and to give me any positive or negative
insights that you think are significant.
Mark:
When do you need this?
Mr. Chen:
At 7:00 A.M. tomo
ow. I want to call our banker tomo
ow morning and get an extension
on PCC’s loan.
Mark:
The banker, Jesse Liu, said that PCC was “growing beyond its financial capabilities.”
What does that mean?
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Mr. Chen:
It probably means that she doesn’t think we can repay the loan within a reasonable period.
I would like you to build a simple financial forecast of our performance for the next two
years (ignore seasonal effects) and show me what our debt requirements will be at the
fiscal years ended 2021 and 2022. I think it is reasonable to expect that PCC’s sales will
grow at 15 percent each year. Also, you should assume capital expenditures of SGD 54.6
million for plant renovations spread out evenly over the next two years and depreciated
over seven years on a straight-line basis. Use whatever assumptions seem appropriate to
you based on your historical analysis of results. For this forecast, you should assume that
any external funding is in the form of short-term debt.
Mark:
But what if the forecasts show that PCC cannot repay the loan?
Mr. Chen:
Then we’ll have to go back to PCC’s owners, New Era Partners and Carolina Pulp &
Paper for an injection of equity. Of course, New Era Partners would rather not invest
more funds unless we can show that the returns on such an investment would be very
attractive, and/or that the survival of the company depends on it. Thus, my third request is
for you to examine what returns on book assets and book equity PCC will offer in the
next two years and to identify the “key driver” assumptions of those returns. Finally, let
me have your recommendation about operating and financial changes I should make
ased on the historical analysis and the forecasts.
Mark:
The plant manager revised his request for a new packaging machine and thinks these are
the right numbers [see the plant manager’s memorandum in Exhibit 4]. Essentially, the
issue is whether to invest now or wait three years to buy the new packaging equipment.
The new equipment can save significantly on labor cost but ca
ies a price tag of SGD
1.82 million. My hunch is that our preference between investing now versus waiting three
years will hinge on the discount rate.
Mr. Chen:
[laughing] The joke in business school was that the discount rate was always 10 percent.
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Mark:
That’s not what my business school taught me! New Era always uses a 40 percent
discount rate to value equity investments in risky start-up companies. But PCC is
easonably well-established now and shouldn’t require such a high-risk premium. I
managed to pull together some data [see Exhibit 5] on comparable companies with which
to estimate the required rate of return on equity.
Mr. Chen:
Fine. Please estimate PCC’s weighted average cost of capital and assess the packaging
machine investment. I would like the results of your analysis tomo
ow morning at 7:00
A.M.
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Exhibit 1
PACIFIC CONTAINER CORP.
Historical Income Statements
Fiscal Year Ended December 31
(SGD XXXXXXXXXX 2020
Sales 71, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,042
Operating expenses:
Production costs and expenses 33,703 38,393 46,492 53,445
Admin. and selling expenses 16,733 17,787 21,301 24,177
Depreciation 8,076 9,028 10,392 11,360
Total operating expenses 58,512 65,208 78,185 88,983
Operating profit 13,412 14,908 14,429 17,059
Interest expense 5,464 6,010 7,938 7,818
Earnings before taxes 7,949 8,897 6,491 9,241
Income taxes* 2,221 2,322 1,601 2,093
Net earnings 5,728 6,576 4,889 7,148
Dividends to all common shares 2,000 2,000 2,000 2,000
Retentions of earnings 3, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,148
*The expected corporate tax rate was 24.5%.
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Exhibit 2
PACIFIC CONTAINER CORP.
Historical Balance Sheets
(Fiscal Year Ended December 31)
(SGD XXXXXXXXXX 2020
Assets:
Cash 4, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,795
Accounts receivable 22, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,486
Inventories 23, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,778
Total cu
ent assets 50, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,059
Gross property, plant & equipment 64, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,153
Accumulated depreciation (4, XXXXXXXXXX, XXXXXXXXXX, XXXXXXXXXX,339)
Net property, plant & equipment 60, XXXXXXXXXX, XXXXXXXXXX,920