Pressed Paper Products, Inc.
Pressed Paper Products, Inc. is involved in manufacturing a variety of specialty material
paper products but their business focal point is tea bags production. A key consideration is that
this company, along with two other firms, The Great Paper Company of Edinburgh and Lincoln
Paper and Fiber, comprise 80% of the tea bag paper market. However, Edinburgh is struggling to
maximize its gap between debt and total capital and therefore has potential to become acquired,
most likely by one of its main competitors to gain considerable market share. The tradeoff
against increased market share would be that the acquiring firm inherits Edinburgh’s hefty debt
and as a consequence, will also suffer losses by not covering capital costs themselves.
Pressed Paper Products’ Board of Directors have hired analysts to evaluate whether the
Edinburgh acquisition will be beneficially profitable for Lincoln and determine whether PPP
should instead pursue Edinburgh for their market share. Lincoln had also previously taken on a
different paper production company that required them to increase their debt obligations and
ultimately did not prove beneficial for Lincoln as its share prices had declined.
To understand Lincoln’s financial situation, an analysis of their outstanding bonds is
required. Lincoln had to issue new debentures and a callable bond with an additional deferred
call provision. And each time a debenture is issued, there are fees that consist of 2% on its
returns and calculated into its cost of capital. Lincoln also has high bond dividend payouts
indicating that there are relatively high risks for its investors. There are also mortgage debts on
its plant and equipment, and thus it is necessary to compare the book value of this property with
its market value, along with basis points inclusion. There is currently a discount available on the
mortgage debts with a capital loss on its investment. The costs of mortgage debt should be
compared to the cost of junior or subordinated debt. Quotes on Lincoln’s treasury bonds are also
a factor in cost of capital, which involve minimal risks because it is issued by the government,
and short-term treasury bills that also involve little risk. The bond that has around 10 years to
maturity has the best potential for risk-free rates.
Lincoln’s bond rating is held at investment grade BBB. It has only $50,000,000 left of
issuing additional debt before its grade will fall and its senior debt will suffer extra 3% basis