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American Chemical Corporation: Financial Analysis: June 2010
American Chemical Corporation: Financial Analysis: June 2010
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The American Chemical Corporation (AMC) is a large, diversified chemical producer. In 1979,
AMC was forced to issue a tender to sell a Sodium Chlorate plant, near Collinsville, Alabama.
Dixon, a specialty chemicals company, was willing to purchase the aforementioned plant for
$12m with the option to invest a further $2.25m on laminate technology. The subsequent
investment in Laminate technology was expected to eliminate graphite costs and reduce power
consumption at the Collinsville plant by 15% to 20%.
We will evaluate the acquisition of the Collinsville by Dixon at the proposed price.
Table 1 identifies the assumptions that have been used for the evaluation of this acquisition.
Table 1
Assumptions Reference
Laminate Technology reduces power by a Pg 3, HBS 9-280-102
mean of 17.5%
Laminate Technology is depreciated over 10 Pg 3, HBS 9-280-102
years
Sodium Chlorate price growth is 8%, per Pg 4, HBS 9-280-102
annum
Power cost (per KWH) growth is 12%, per Pg 4, HBS 9-280-102
annum
Plant Life is 10 years Pg 1, Assessed work Sheet
Plant Salvage Value is zero Pg 1, Assessed work Sheet
EBIT is flat after 1984 Pg 1, Assessed work Sheet
Capital Expenditures: $600,000 per annum Pg 1, Assessed work Sheet
after 1984
Net Working Capital Remains flat after 1984 Pg 1, Assessed work Sheet
Definition of “Flat” Pg 4 http://www.imf.org/external/pubs/ft/wp/2006/wp06218.pdf
6.5% is the Equity Risk Premium Slide 21, Risk and Return, class notes-
http://www.investopedia.com/articles/04/012104.asp
Tax rate is 48.69% Exhibit 7, HBS 9-280-102
From 1984 to 1989, the following growth Exhibit 8 , HBS 9-280-102
rates are used
4 year Growth rate is used for Variable Costs Exhibit 8, HBS 9-280-102
Capital investment is based on figures from Exhibit 8, HBS 9-280-102
1980-1984
PPE and depreciation is based on figures Exhibit 8, HBS 9-280-102
from 1980-1984
Beta Debt is zero Pg 443, Demarzo 2007
a. Dixon Beta
Exhibit 5 identifies the Equity Betas’ of selected Sodium Chlorate producers. Exhibit 7
identifies a beta of 1.06 for Dixon. However, as previously stated, Dixon is not currently a
Sodium Chlorate producer thus the suggested Beta fails to provide an insight into the
systematic risk of the project vis-à-vis the sodium chlorate industry.
We decide against calculating, and thus using the average equity beta of Southern and
Brunswick as market representatives, as the cited chemical producers account for 5% of the
Southern Eastern US market.
We therefore, calculate the average beta of the sodium chlorate industry by delevering the
equity beta of market participants, as identified in Exhibit 7.As a noted market participant; we
include American Chemical Corporation (ACC) in our calculations.
Table 2
Based on the figures extracted from Exhibit 1 & 5, a mean ßU of .92 is yielded, suggesting that
the related business operations of the selected market participants’ is less volatile than the
market thus, in the absence of leverage, the sodium chloride industry has the traits of being
low risk / return.
Specification 22 identifies the formula used to relever and adjust ßU with Dixons capital
structure.
The pre-tax adjusted WACC is 15.94% nonetheless; for the purpose of valuation we
will use 14.19%
In order to remain prudent, we use 6.5% as the ERP, and 9.5% for the Rf
(6) RU = Rf + BU * ERP
15.48 % = 9.5% + (.92 * 6.5%)
Thus the unlevered cost of capital, which can be used for APV analysis6, is 15.48%
bond.html
4 The Equity Risk Premium is typically between 4% - 7% http://www.investopedia.com/articles/04/012104.asp
5 The formulae for the unlevered cost of capital is determined from Pg 639, 2007, Demarzo, “Corporate
Finance”
6 Although not requested, for comparative purposes the RWACC has also been calculated. The results can be
found in Q1.ACC.SBS.xls
a) Project the incremental cash flows associated with the acquisition of Collinsville
Although the attributes relating to the period 1980 till 1984 were readily available from exhibit
8, our model was developed to be fully computational.
Thus, we first computed the operating income, (EBIT) by subtracting7 the cost of goods sold
and depreciation from the revenue.
We then calculated the Earnings before interest and after tax with specification 7:
Capital Expenditures include expenditures on new and replacement property, plant and
equipment. Thus, we calculated Capital expenditures by measuring the increase in net
property, plant and equipment plus depreciation. (Source: Pg174 Copeland et al, 1996)
The third phase of our calculation determined the change in working capital between two time
periods. In order to do so, we first calculated the working capital. This was achieved by the
summation of Accounts receivables’, inventories less accounts payable.
In light of the aforementioned, specification 8 was used to determine incremental cash flows.
The cited schema was also applied for the period 1985-1989 however, the following line items
had to be forecasted, based on the assumptions cited in table 1.
Forecasted Items
Table 3
Year 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989
FCF -
($000) $12,000 $1,206 $1,407 $1,891 $2,074 $2,073 $2,214 $2,497 $2,594 $2,890 $3,021
7
Manufacturing Cost and the “Other charges” as labeled in exhibit 8
As per table 4, using the WACC approach, we discount the FCF to Present Value.
Table 4
Year 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989
-
FCF($000) $12,000 $1,206 $1,407 $1,891 $2,074 $2,073 $2,214 $2,497 $2,594 $2,890 $3,021
Discount
Rate 1.00 0.88 0.77 0.67 0.59 0.52 0.45 0.40 0.35 0.30 0.27
Discount -
(C.F) $12,000 $1,061 $1,083 $1,267 $1,224 $1,078 $996 $999 $908 $896 $816
PV $10,299
The present value of the Collinsville plant, without laminate technology is $10,299,000
3. Project the Incremental Cash Flows associated with the investment in Laminate
Technology
Reference: Q3.ACC.SBS.xls
We consider the cash flows yielded by the installation of laminate technology independent to
the cash flows of Collinsville plant.
Installation of laminate technology can result in the elimination of graphite costs, and a
reduction in power consumption by 17.58%. Thus, we sum the cited to compute cost savings,
and depreciate the investment over 10 years.
Table 5 depicts the incremental cash flows associated with this investment.
Table 5
Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989
FCF -$2,140 $1,209 $1,402 $1,538 $1,677 $1,830 $1,999 $2,187 $2,394 $2,625
Discount
Rate 0.88 0.77 0.67 0.59 0.52 0.45 0.40 0.35 0.30 0.27
Discounted
CF -$1,883 $931 $939 $907 $872 $824 $800 $765 $718 $709
PV $7,465
The present value of the incremental cash flows associated with an investment in Laminate
Technology is $7,465,000.
8 Actual power reduction is between 15%-20% however, we will take the mean
4.b What is the NPV of the acquisition with Laminate Technology, with a 25%
probability that the technology fails after the plant has been purchased
Reference: Q4b.ACC.SBS.xls
We develop a FCF absent of any potential benefits from the installation of Laminate
Technology nonetheless; we maintain the following assumptions:
Thus the NPV of Collinsville plant, including the expectation of Laminate Technology
failing, in conjunction with the aforementioned assumptions is $- 2,904,000, at a 100%
failure rate.
The NPV of the laminate technology project is $5,582,000, at a 100% success rate.
Inline with the NPV doctrine, we recommend that Dixon should abstain from acquiring the
Collinsville plant, as a negative NPV of $1701 million equates to concurrently reducing
shareholder value. Nonetheless, it is recommended that Dixon should acquire the Collinsville
plant, in conjunction with Laminate Technology. This recommendation is supported by the
results computed in Q4.B, despite a 25% probability of technology related failure, a positive
NPV is deducible.
As per Page 4 of the case, the acquisition of Collinsville plant would complement Dixons
strategy of supplying chemicals’ to the paper and pulp industry. According to page 2 of the
case, one requires approximately $16m to finance a newly built 40,000 ton sodium chlorate
plant ergo, relative to building a new plant; it is recommended that Dixon acquire the
Collinsville with Laminate technology as the acquisition is less capital intensive, does not
entertain a construction building lag and impedes on the competition.
It is quite clear that Laminate technology contributes to the economic efficiency of the
acquisition of Collinsville, construction, development and installation delays will affect the
NPV therefore, Dixon should contractually hedge itself against the aforementioned.
As power consumption accounts for 55% - 60% of manufacturing cost, Dixon should
investigate the possibility of structuring Forward Power purchasing contracts with the
Tennessee Valley Authority.
Websites:
Books:
Copeland et al, 1996, Valuation, Measuring and Managing the Value of Companies,2nd Edition,
Mckinsey & Company, Inc.