E.I.

du Pont de Nemours and Company: Titanium Dioxide

Assignment: There is no write up due for duPont Titanium Dioxide. We will discuss
issues here as time permits. Good case to discuss real asset options.

Questions to discuss prior to class

1. What are Du Pont's competitive advantages in the TiO2 market as of 1972? How
permanent or defensible are they? What must Du Pont do to retain its competitive
advantages in the future?

2. Given the forecasts provided in the case, what are the relevant cash flows associated
with the following three strategies for managing DuPont's TiO2 business?

Strategy I: Status Quo. Hold production capacity at 325,000 tons per year.
Strategy II: Maintain Strategy. Build capacity to 482,000 tons by 1985.
Strategy III: Growth Strategy. Build capacity to 685,000 tons per year by 1985.

Notice, the status quo is not directly discussed in the case, it just gives a benchmark of
comparison between the two strategies being considered (maintain vs. growth).

3. How much risk and uncertainty surround these future cash flows? What are particular
sources of risk facing Du Pont?

4. How might competitors respond to Du Pont's choice of either strategy in the TiO2
market?

5. What other factors should Du Pont consider in making this decision?

6. Which strategy, maintain or growth, looks more attractive for Du Pont? What are the
key factors leading to your conclusion?

FYI, in 1972, bond yields and recent inflation data were approximately as follows:

Long-term Treasuries = 6.2%

Aaa Corporate bonds = 7.2%
Baa corporate bonds = 7.8%
Inflation rate (CPI) = 3.2%

p 4, column one:

"Ongoing capital expenditure for maintenance and replacement were expected

to approximate depreciation allowances over time. Thus, should TiO2
production terminate at any point in the future, it was believed that DuPont's
investment in working capital and book value of other assets could be
completely recovered."

What do these two sentences telling you?

 The first sentence is telling you that maintenance capital expenditures (not
growth capital expenditures, which are estimable from case numbers, but
maintenance capex, which is not) will cancel with the depreciation addback.
More explicitly, a method of calculating the annual free cash flow of a project,
FCF is as follows:

FCF = Operating profit before tax (after depreciation) - tax

+ (Depreciation - Maintenance CAPEX)

- Growth CAPEX - Change in working capital requirements

They are telling you that the italicized row may be left out of the equation, a
shortcut that allows you avoid estimating depreciation.

The second sentence is giving you a shortcut to calculate the terminal value of
the investment alternatives at the end of the forecast interval. The authors of
the case assume you don’t know how to calculate continuing values of
investments, etc., so they are saying you should use the remaining book value
of assets plus any working capital invested to assess the project’s terminal
value. You know how to do terminal values (Project cash flows note), so do
it. This second sentence is particularly troubling if misinterpreted to mean
that investments in either the growth strategy or the maintain strategy are not
really risky, because the company can always get their incremental
investments out “at any point in the future.” This is not what the sentence
means. These investments are risky investments... if someone should find a
better substitute for TiO2, these plants will not be nearly as valuable in their
next best use.
(a) Statement of Problem.

Recent events have dramatically altered and created excess demand in the titanium dioxide industry. Sulfate
process plants were forced to make major capital expenditures to comply with new environmental legislation
and the price of rutile ore increased dramatically. Du Pont had developed its ilmenite chlorine process, a
technology that processes at lower grade ores, and maintains a competitive advantage over other firms in the
industry. Management currently reevaluated their capacity expansion strategy to see whether or not to expand
or maintain their current market share.

(b) Statement of Facts and Assumptions.

We assumed sales of $100 million in 1972 based off of Exhibit 2’s dollar value of shipments. The tax rate
was assumed to be 48%, as noted on page 76 footnotes. The terminal value was calculated as the sum of all
capital expenditures and the change in working capital.

(c) Analysis.

Du Pont has a few competitive advantages over its competitors as of 1972. Due to the size of the firm and its
technological superiority, Du Pont has a dominant position in many markets. Du Pont also has a competitive
advantage in the chloride process because of the recent enacted environmental protection legislation, which has
made TiO2 production costs much higher. Du Pont will benefit from this because most of its production uses the
ilmenite chloride process, which is much cheaper than the processes used by competitors.

Using a 5% discount rate, Du Pont’s growth strategy will have an $886 million NPV and their maintain
strategy will have a NPV of $715 million at a 5% (NPV at other discount rates available on spreadsheet). The
growth strategy has a higher NPV compared to the maintain strategy for discount rates under 23%. The Internal
rate of return could not be calculated because there is no initial outlay for either strategy.

If Du Pont chooses a maintain strategy, they run the risk of losing market share in the near future. Their
competitors may add capacity and flood the market. Since US firms currently dominate the domestic market for
TiO2, there is the possibility tariffs on TiO2 imports will be lowered and foreign markets will gain more market
share. In addition, competitors may invest in R&D and develop a cost effective process or imitate Du Pont’s
current ilmenite chloride technology.

On the other hand, if Du Pont chooses a growth strategy, competitors may also try to gain market share by
investing in a new innovative, cost effective process or develop a process comparable to Du Pont’s ilmenite
chloride technology.

Du Pont should also consider other factors such as the possibility of price increases or limited access to
ilmenite ore, a key component of the ilmenite chloride technology. There are also the usual risks of technical
failure, delayed startups, declining prices, and diminished cash flow from TiO2 operations.

The growth strategy looks the most attractive since the net present value is higher for all discount rates
between 5%-23%. Therefore, we’d recommend Du Pont to pursue a growth strategy with a discount rate of 5%,
since it offers the highest NPV. If Du Pont is able to expanding capacity, restrict the licensing of the ilmenite
chloride process, and achieve forecasted sales of TiO2, it’ll improve Du Pont’s competitive position in the
industry.

Overview
In 1972, Du Pont found itself in a fortunate position as it was faced with the following two options:
1. Continue with its existing strategy and maintain its current revenue stream; or
2. Modify its strategy and invest additional capital to increase its revenue stream in the future.
As one can imagine, multi-million dollar investment decisions such as these are not easily made and require a
tremendous amount of due diligence to include financial forecasting, labor ramifications, and extensive
research.
Market Position
Du Pont's position in the market was fortunate for several reasons. First, Du Pont was a leader in the Titanium
Dioxide industry possessing the highest capacity for use of the ilmelite chloride process. Two recent
developments in the industry, sharp increases in the cost of rutile ore required for the sulfite based process and
the heightened environmental regulations enacted against domestic sulfur based plants made the ilmelite
chloride process more attractive. Du Pont had a competitive advantage in the ilmelite chloride process
accounting for approximately 60% of the total market production in 1970. This advantage was strengthened by
the fact that the number two producer, NL Industries, was highly leveraged and the other producers in the
market were relatively much smaller. This competitive advantage translated to an average pre-tax profit margin
of 40% doubling that of its competitors in the industry. Therefore, the company could afford to cut prices as
needed to keep future competitors out of the industry and maintain market share.

Finally, Du Pont was a large diversified company that spanned a number of different industries. While the
pigments department, responsible for the production of titanium dioxide, was an important part of Du Pont's
holdings, it was still the second smallest of Du Pont's ten departments. Therefore, the risk associated with the
pigment department was fairly mitigated.
The Issue
The issue facing Du Pont is whether or not to invest additional money into this capital intensive process and
expand production. Granted, the added production would provide higher cash flows in the future; however, it is
uncertain whether or not such an investment would generate the desired returns. Through our analysis, we
believe, Du Pont should move forward with the investment and increase production. Using the numbers in
Appendices A and B, the "maintain" strategy of non-expansion leads to positive future cash flows of $50M+,
while the "growth" provides over $130M. Through our analysis, we believe the decision is fairly simple: pursue
the "Growth" strategy.
Other Considerations
There are always inherent risks involved in pursuing a particular course of action. For example, cost overruns,
regulation, and the development of huge economies of scale were risks that were obviously present for Du Pont.
However, it already had the funding and expertise to build these facilities and could do so more effectively than
any present competitor. The company also had the name and established corporate presence necessary to
facilitate such development. With the contacts Du Pont had established throughout the political and labor
world, it would likely encounter fewer problems than any other company seeking to enter the industry or expand
in it.

Consequently, the risks surrounding these future cash flows appear to be minimal. Du Pont has the most cost
effective and environmentally clean process, and there appears to be no shortage of the necessary raw material
given that it was just discovered a few years prior. As a result, the growth strategy appears to be the more
attractive option.

Du Pont should examine other factors as well. For example, it should determine whether or not there is a better
use for the capital inside the company. With no knowledge of other opportunities, it is difficult to get a gauge
where it should apply its excess capital. As our analysis shows, it would be difficult to exceed the NPV gain of
$80M(+) in choosing the "growth" strategy over the "maintain" strategy.
Sensitivity Analysis
The company should also conduct some "sensitivity analysis" to verify all external factors that could possibly
affect the raising or lowering of projected future cash flows (insert our analysis of such sensitivities here – best
case, worst case, most likely).
Conclusion
Our conclusion in this case, as indicated above – and verified again through our sensitivity analysis, is to pursue
a "Growth" strategy. Du Pont has much to gain if they were to choose this course of action. One of their
smaller industries could grow to become a more significant contributor to the company and could fund future
growth. As stated, the risks to choosing such a path are minimal, especially with the recent decline of many of
its competitors. Finally, they have the industry knowledge and presence to be able to expand in the right way
without attracting the ire of legislators and environmentalists.

Du Pont has been handed a very fortuitous set of circumstances. Some of the factors can be attributed to their
own decision making (to diversify production using the ilmenite process) and others can not be (environmental
crackdowns on sulfur plants, high cost of rutile ore). The company should leverage these circumstances and use
them as opportunity to take a small part of their company and turn it into a future growth engine.