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Dixon’s Purchase on Collinsville: The Victory of Laminate

Report for Dixon Corporation: The Collinsville Plant

Yangfan Chen　 113710773 Ruoping Lin 113661082 Yue Lin 113738890 Ren Wang 113852749

Dixon’s Purchase on Collinsville: The Victory of Laminate Dixon has an opportunity to buy Collinsville plant, a plant used to produce sodium chlorate (NaClO3). With Collinsville, Dixon can therefore complete its production chain of chemicals used in paper and pulp industries. But the price American charged, $12 million, seems to be relatively high. However, in fact, the relatively high price can be regarded as an appreciation brought by new technology and relative services. Therefore, Dixon should purchase Collinsville and pay for the laminate in 1980. A reasonable WACC for Collinsville First of all, we need to get a reasonable estimation of the project’s debt ratio. We assume that Dixon will keep the project’s debt ratio the same as the entire company’s debt ratio. Plus we assume that the market value of debt equals to book value, because over 85% of the debt is newly added. Therefore, the debt ratio is 16.99%. This value can be verified by the mean debt ratio, 18%, of Brunswick Chemical and Southern Chemicals, who run their business only in sodium chlorate production. Secondly, we calculate the market premium data using weekly market premium data from June 1974 to June 1979 collected by Fama and French. The market premium is 4.512% (Appendix 1). Thirdly, the cost of debt is 11.25%. Therefore, using the return of long-term treasury bonds, 9.5%, as risk free rate, we get the beta of debt, 0.388. For the beta of unlevered equity, we use the mean unlevered equity of Brunswick Chemical and Southern Chemicals. Plus, for Brunswick Chemical and Southern Chemicals, we assume that their beta of debt is 0, because they may get loan in other ways. Therefore we get the unlevered beta of sodium chlorate production industry, 1.033. Together with Dixon’s beta of debt and debt ratio, we get the beta of equity, 1.165. Then, using CAPM model, the cost of equity is 14.76%. Finally, using the data in 1979, we calculate the tax rate of Dixon, 48.69%. Therefore, with the debt ratio, cost of debt, cost of equity, and tax rate of Dixon, we get the WACC of the whole project, 13.23%. Can Collinsville generate positive NPV without laminate? Since Dixon has made prediction for the financial data from 1980 to 1984, we can calculate the project NPV without laminate just with a few simple assumptions. Except for the growth rate of sodium chlorate and power cost being 8% and 12% respectively, we assume that the growth rates of graphite, salt and other, labor, maintenance, other, and selling are 6.5%, 5.6%, 10%, 10%, and 0.7% respectively. Besides, the other cost in fixed cost is $1,150,000 per year. So we can get the EBIT of each year from 1980-1989 (Appendix 2). We assume that the capital expenditure is used to renew the plant, and will be depreciated over 10 years in straight line method. Therefore, the new plant value at the end of each year should be the value of plant at the beginning of each year minus depreciation of the original plant, plus capital expenditure, and minus the depreciation of capital expenditure (Appendix 3). Therefore, we can get the free cash flow of each year (Appendix 4) and calculate the

NPV of the whole project, which is -$956580. Is Laminate worthy of the additional payment? The laminate technology should be the main reason why American charges Dixon for more fee on Collinsville plant than it should be. If the whole project plus laminate can generate positive NPV under the most conservative estimation, then Dixon will have enough reason to take the project and accept the relatively high purchasing price. To calculate the free cash flow of the project with laminate, we assume that the power cost can be saved by 15% per year, which is the lowest value of Dixon’s estimation. Therefore, we get the operating profit of Collinsville in each year from 1980-1989 (Appendix 5). Then we can calculate the free cash flow in each of these years (Appendix 6). Finally we get the NPV of the whole project, $4,213,350. Since the project plus laminate generate positive NPV, it seems that Dixon has no reason to refuse the project. What if the situation changes? There are three factors that we think may change, debt ratio, market premium, and power cost. Therefore we conduct sensitivity analysis for these three factors respectively (Appendix 7). For debt ratio, we are worried about what if it decreases, because when it increases, the NPV will be greater. In the sensitivity analysis, even when debt ratio is 0, the project plus laminate generate positive NPV. For market premium, since from June 1974 to June 1979, the average weekly market premium of S&P 500 was negative, we may underestimate the market premium for the evaluation. When we increase the market premium to 8%, the NPV is nearly 0. However, 8% would be relatively too large for market premium. So we can still conclude that Dixon should take the project with laminate. For the power cost, we are worried that the energy crisis may raise the power price, leading to underestimation of power cost. We change the power price as a whole while keep the 12% annual growth constant. When the power price increases by a little over 15%, the project NPV runs close to 0. We consider that the energy crisis may not last for 10 years, so there is little chance that the power price for the 10 years will increase by over 15%. Therefore, Dixon still has the incentive to take the project. Appendix 1 The formulation used to calculate market premium Market Premium = (1 + 9.5%/52 + ΣMkt-Rf/262)52 – 1 – 9.5%， where Mkt-Rf is the weekly market premium over the past five years. Source of Mkt-Rf: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

Appendix 2 Income Statement of Collinsville Plant without Laminate 　 Revenues Sales-tons Average price/ton Sales - $000 Manufacturing costs Variable - Power

1980 　 32,000 $415

1981 　 35,000 $480

1982 　 38,000 $520

1983 　 38,000 $562

1984 　 38,000 $606

$13,280

$16,800

$19,760

$21,356

$23,028

　 $6,304

　 $7,735

　 $9,386

　 $10,526

　 $11,780

645

791

875

940

992

1,285

1,621

1,753

1,836

1,956

$8,234

$10,147

$12,014

$13,302

$14,728

$1,180

$1,297

$1,427

$1,580

$1,738

256

277

299

322

354

1,154 $2,590

1,148 $2,722

1,179 $2,905

1,113 $3,015

1,153 $3,245

$10,824

$12,869

$14,919

$16,317

$17,973

　 $112

　 $125

　 $138

　 $152

　 $168

451

478

508

543

591

$1,060 $1,623

$1,110 $1,713

$1,160 $1,806

$1,210 $1,905

$1,270 $2,029

1985 　

- Salt & Other Total variable Fixed - Labor - Maintenance - Other Total fixed Total manufacturing costs Other charges Selling

Depreciation Total

1988

1989

　

　

1056.48 2065.53 6 16315.6 2

38000 706.838 4 26859.8 6 　 14776.8 3 1125.15 1 2181.20 6 18083.1 9

1911.8

2102.98

38000 763.385 5 29008.6 5 　 16550.0 5 1198.28 6 2303.35 4 20051.6 9 2313.27 8

389.4 1150

428.34 1150

3451.2 19766.8 2 　

3681.32 21764.5 1 　 170.360 2 620.919 4 1390

38000 824.456 3 31329.3 4 　 18536.0 6 1276.17 5 2432.34 1 22244.5 7 2544.60 6 518.291 4 1150 4212.89 7 26457.4 7 　 172.753 6 652.353 4 1510 2335.10 7

38000 890.412 8 33835.6 9 　 20760.3 9 1359.12 6 2568.55 2 24688.0 6 2799.06 6 570.120 5 1150 4519.18 7 29207.2 5 　 173.962 9 668.662 3 1570 2412.62 5

38000 654.48 24870.2 4 　

169.176 R&D

1987 　

13193.6 - Graphite

1986 　

605.775 1330 2104.95 1

2181.28

471.174 1150 3934.45 2 23986.1 4 　 171.552 8 636.442 4 1450 2257.99 5

Operating Profit

$833

$2,218

$3,035

$3,134

$3,026

2998.47 3

2914.07

2764.50 9

2536.76 1

2215.81 1

Appendix 3 The Plant Value, Capital Expenditure, and Depreciation in Each Year from 1980 to 1989 　 PPE(beginning of the year) Depreciation CapEx DepWithNewCapEx Net PPE 　 Total Depreciation

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

10600 1060 500 0 10040

10040 1060 500 50 9430

9430 1060 500 100 8770

8770 1060 600 150 8160

8160 1060 600 210 7490

7490 1060 600 270 6760

6760 1060 600 330 5970

5970 1060 600 390 5120

5120 1060 600 450 4210

4210 1060 600 510 3240

　

　 1060

　 1110

　 1160

　 1210

　 1270

　 1330

　 1390

　 1450

　 1510

1570

CapEx used to renew the PPE and the renewed part will be depreciated in straight line method for ten years. Since the data in Dixon's prediction doesn't match, use the total depreciation as the standard to calculate the Capital expenditure in each year. We also assume that the CapEx after 1983 will stay $600000

Appendix 4 Free Cash Flow for Collinsville Project without Laminate

　 EBIT

1979 　

Tax

48.69%

1980

1981

1982

833.00

2218.00

3035.00

405.59

1079.94

1477.74

427.41 　 500.00 1060.0 0 　 1328.0 0 598.00

1138.06 　 500.00

1557.26 　 500.00

1110.00 　 1680.00

1160.00 　 1976.00

756.00

889.00

924.00

1087.00

1512.00 316.00 　

1778.00 266.00 　 1951.26 1280.90 8 3232.17

NI 　 CapEx

　 　 　

Depreciation 　

　 　

A/R Inventory

　 　

A/P

　

NWC ΔNWC 　

　 　

FCF

　

730.00 1196.0 0 -204.00 　 1191.4 1

　 Discount Rate

　

　

1432.06 1110.73 9

　

2542.79

Terminal Value PPE*T NWC TV PV-TV

1400

13.23% 　 1611.64 3044 4655.64 $1,308.80

1983 3134.0 0 1525.9 4 1608.0 6 　 600.00 1210.0 0 　 2136.0 0 961.00 1175.0 0 1922.0 0 144.00 　 2074.0 6 1402 3476.0 6

1984

1985

1986

1987

1988

1989

3026.00

2998.47

2914.07

2764.51

2536.76

2215.81

1473.36

1459.96

1418.86

1346.04

1235.15

1078.88

1552.64 　 600.00

1538.52 　 600.00

1495.21 　 600.00

1418.47 　 600.00

1301.61 　 600.00

1136.93 　 600.00

1270.00 　 2303.00

1330.00 　

1390.00 　

1450.00 　

1510.00 　

1570.00 　

1036.00

2487.24 1118.88

2686.22 1208.39

2901.12 1305.06

3133.21 1409.47

3383.86 1522.22

1267.00

1368.36

1477.83

1596.06

1723.74

1861.64

2072.00 150.00 　

2237.76 165.76 　

2416.78 179.02 　

2610.12 193.34 　

2818.93 208.81 　

3044.45 225.51 　

2072.64 1525.19 5

2102.76 1667.07 8

2106.19 1824.16 6

2075.13 1998.16 8

2002.80 2190.98 5

1881.42 2404.74 3

3597.84

3769.83

3930.36

4073.30

4193.79

4286.16

Appendix 5 Income Statement of Collinsville Plant without Laminate 1980

　 Revenues Sales-tons Average price/ton

　 32000 415

Sales - $000

13280

1981 　

1982 　

　 6304

- Graphite - Salt & Other

645 1285

Total variable

8234

Fixed - Labor

1180

- Maintenance

256

38000

480

520

562 23028

　

19760 　 7978.1 0

8947.1 0

1621

1753

1836

9731.1

451

1427

1580

1987

277 1148

299 1179

322 1113

2722

2905

3015

1153 3245

　

38000 763.385 5 29008.6 5 　 14067.5 4 0 2303.35 4

13280.1

38000 706.838 4 26859.8 6 　 12560.3 1 0 2181.20 6 14741.5 1

1911.8

2102.98

389.4 1150

428.34 1150

3451.2

3681.32 18422.8 3 　 170.360 2 620.919 4 1390 225 1615

38000 824.456 3 31329.3 4 　 15755.6 5 0 2432.34 1 18187.9 9 2544.60 6 518.291 4 1150 4212.89 7 22400.8 9 　 172.753 6 652.353 4 1510 225 1735 2560.10 7 6368.34 5

38000 654.48 24870.2 4 　 11214.56 0 2065.53 6

15214 　

12636.1 　

13798.1 　

138

　 168 152

16731.3 　 169.176

591 478 1110 225 1335

508 1160 225 1385

543 1210 225 1435

1938

2031

2130

833

1270 225 1495 2254 5560

3944.25

5092.9

5427.9

1988

　

16370.9 2313.27 8

354

125 1060 　 1060 1623

1986 　

1738

10917.75

R&D

0 1956

10783.1

10824 　 112

Operating Profit

　 10013

1985 　

11969

1154 2590

Other charges Selling

Depreciation-PPE Depreciation-Laminate Total Depreciation Total

21356 　

6574.75 0

1297

Total manufacturing costs

　 38000 606

38000

8195.75

- Other Total fixed

1984

35000

16800 Manufacturing costs Variable - Power

1983 　

605.775 1330 225 1555 2329.95 1 5808.99 3

2406.28 6030.74 6

471.174 1150 3934.45 2 20305.3 5 　 171.552 8 636.442 4 1450 225 1675 2482.99 5 6220.30 3

1989 　 38000 890.4128 33835.69 　 17646.33 0 2568.552 20214.88 2799.066 570.1205 1150 4519.187 24734.07 　 173.9629 668.6623 1570 225 1795 2637.625 6463.995

Appendix 6 Free Cash Flow for Collinsville Project without Laminate 　 EBIT Tax NI 　 CapEx Depreciation 　 A/R Inventory A/P NWC ΔNWC

1979 　 48.69% 　 　 　 　 　 　 　 　 1400 　

　

　

FCF

　

Terminal Value PPE*T Laminate*T NWC TV PV-TV

　 1611.64 109.55 3044 4874.74 $1,339.60

1980 833.00 405.59 427.41 　 500.00 1060.00 　 1328.00 598.00 730.00 1196.00 -204.00 2250.00 1058.59

1981 3944.25 1920.46 2023.79 　 500.00 1335.00 　 1680.00 756.00 924.00 1512.00 316.00

1982 5092.90 2479.73 2613.17 　 500.00 1385.00 　 1976.00 889.00 1087.00 1778.00 266.00

1983 5427.90 2642.84 2785.06 　 600.00 1435.00 　 2136.00 961.00 1175.00 1922.00 144.00

1984 5560.00 2707.16 2852.84 　 600.00 1495.00 　 2303.00 1036.00 1267.00 2072.00 150.00

1985 5808.99 2828.40 2980.59 　 600.00 1555.00 　 2487.24 1118.88 1368.36 2237.76 165.76

1986 6030.75 2936.37 3094.38 　 600.00 1615.00 　 2686.22 1208.39 1477.83 2416.78 179.02

1987 6220.30 3028.67 3191.64 　 600.00 1675.00 　 2901.12 1305.06 1596.06 2610.12 193.34

1988 6368.34 3100.75 3267.60 　 600.00 1735.00 　 3133.21 1409.47 1723.74 2818.93 208.81

1989 6464.00 3147.32 3316.68 　 600.00 1795.00 　 3383.86 1522.22 1861.64 3044.45 225.51

　

　

　

　

　

　

　

　

　

2542.79

3232.17

3476.06

3597.84

3769.83

3930.36

4073.30

4193.79

4286.16

Appendix 7 Sensitivity Analysis 　 initial 　

NPV-Collinsville -2389.99 　

NPV project 2426.09 　

initial value=16.99 debt ratio=15% debt ratio=10% debt ratio=5% debt ratio=0 　 initial value=4.5% when Market premium=6% when Market premium=7% when Market premium=8% when Market premium=9% 　 initial value= when power cost increase by 5% when power cost increase by 10% when power cost increase by 15% when power cost increase by 20%

　

　 -2466.08 -2653.47 -2835.35 -3011.94

　 　

2287.69 1947.25 1617.39 1297.70 　 　

-2993.40 -3367.26 -3717.96 -4047.3 　 　

1331.23 656.17 25.4 -564.58 　 　

-3159.39 -3928.79 -4698.19 -5467.58

1656.70 887.3 117.90 -982.73