Mead

UVA-F-0982

MEAD CORPORATION: COST OF CAPITAL

Do

On February 14, 1991, Cheryl Harris, business analyst at Mead Corporation, had just begun
the process of estimating Mead's cost of capital for the fourth quarter of 1990. Like most other major
corporations, Mead used its weighted-average cost of capital (WACC) to evaluate new investment
proposals as well as to measure corporate anddivisional performance. Mead was unique, however,
in its practice of updating the hurdle rate every quarter and analyzing the factors responsible for its
change. Looking back at the company's history of WACC estimates, Ms. Harris observed that
Mead's cost of equity had been increasing relative to its cost of debt over the past few years. Hence,
as part of her analysis, she hoped to explain why thecost of equity had increased and recommend
whether the company should consider the increase a problem. Her more immediate concern,
however, was the presentation she was to give the next morning to William Enouen, Mead's chief
financial officer, who had asked to see Ms. Harris's WACC estimate.

No

Mead Corporation

y
op

tC

Mead Corporation was founded in 1846 by Daniel E. Mead andincorporated in 1930. In the
ensuing years, Mead, Inc., grew to become a leading producer of paper and forest products. Included
in the company's product line of forest derivatives were printing paper, writing paper, specialty
paper, lumber, wood pulp, corrugated containers, and packaging products. The company also owned
and operated a national distribution network for paper packaging andsupplies. For beverage
packages and packaging systems as well as for paper-based school and office supplies, Mead was
the leading manufacturer in the United States.
In addition to its forest and paper-based products, Mead had been involved in electronic
publishing and the development of color imaging. Mead Data Central (MDC), a wholly owned
subsidiary of Mead, Inc., owned several publishingcompanies--for example, The Michie Company
in Charlottesville, Virginia, which published and distributed the legal statutes of 23 states. MDC
also marketed the LEXIS® and NEXIS® information services. LEXIS was a computer-based dataretrieval system designed for legal research that had been expanded to include financial information
from leading investment banks, brokerage firms, and researchcompanies. NEXIS was an on-line
general-information-retrieval service frequently available in libraries and news departments of the
print and broadcast media.

______________________________________________________________________________
This case was written by Kenneth Eades for the purposes of classroom discussion. Some figures
have been changed at the request of the company. Copyright © 1991 bythe University of Virginia
Darden School Foundation, Charlottesville. VA. All rights reserved. Rev 5/95

-2-

UVA-F-0982

After having invested approximately $200 million over five years in the development of its
color-imaging process called Cycolor®, Mead had announced in December 1990 that the demand
for color copying was growing too slowly to justify remaining in the business. Thewriteoffs
associated with the discontinuance had resulted in Mead's fourth-quarter earnings per share falling
from the third-quarter figure of $0.63 to $0.17. The company projected that the writeoffs would be
completed before the second quarter of 1991, at which time profits were expected to return to
normal. The announcement regarding discontinuation of its color-imaging business did not appearto have adversely affected Mead's common stock price, which had risen to $25.75 on December 31,
1990, from $24.25 on October 1, 1990.

Do

Mead's Cost of Capital

No

Mead had conducted an internal study in 1984 of the company's cost-of-capital calculation
method. Subsequently, top management implemented a strategy to estimate the cost of capital each
quarter and decompose it into its...