AMERICAN

CORPORATION

CHEMICAL

Executive Summary
Dixon, an American specialty chemical producer, wants to buy Collinsville plant from
American Chemical Corporation, another typical chemical company in 1979. Dixon wants
to diversify its product line buy acquiring the aforesaid plant, which produces sodiumchlorate to supply to paper producers in Southeastern part of the US. This plant initially
cost USD 12 million and additional USD 2.25 million needed to buy laminate technology
to increase efficiency and profitability of the plant in order.
Dixon has conducted thorough marketing research for the industry providing cash flow
analysis on purchase of the plant. The cash flow analysis based with and without laminate
technology cases, where the company should decide whether it should go on further to buy
that plant and technology.
Calculating of WACC
2.1 Assumptions for calculations in the case:
Plant life is 10 years (p.4)
Salvage value of plant is 0 (p.4)
Book value of plant at end of 1979 is 10.6 million (=12 million purchase price- 1.4 million
working capital)
Tax rate is 48% (calculated from Exhibit 7)
For the period from 1980 to 1984: all data of sales, depreciation and manufacturing and
other costs are given in the case (Exhibit 8)
For the period from 1984 to 1989 we use the below assumption:
Price growth rate is 8% (p.4)
Power cost growth rate is 12% (p.4)
Net working capital is always 9% of sales (Exhibit 8, current asset and liability items
remain historical to sales)
PPE and depreciation are based on historical data in 1980-1984 period (Exhibit8)
Capital investment are based on historical data in 1980-1984 period (Exhibit 8)

Variable and fixed costs: we use 4-year average growth rates calculated based on Exhibit 8.
So non-power variable cost growth rate is 11%, fixed cost growth rate is 6%, selling
expenses growth rate is 7% and R&D expenses growth rate is at5%
- To use this 4-year average growth rates, we assume that the scale of operations of this
plant is constant so we need to adjust such cost growths to account for inflation. If the scale
increases we should consider growths in costs on percentage of sale basis.
Cost of capital:
a. Calculate beta of sodium chlorate:
The of Dixon is 1.06 (Exhibit 7). This beta may be irrelevant to the project to buy
Collinsville plant because Dixon produces specialty chemical products but never produce
sodium chlorate. The systematic risk of the project could be the risk of the production of
sodium chlorate in the industry. Therefore, we calculate beta of the project based on the
beta of the sodium chlorate industry.
We do not simply use the beta of Brunswick and Southern, 2 firms purely produce sodium
chlorate, because they are small in the industry and their stocks might not be traded largely
on the market. Hence, we decide to calculate the beta of all firms that produce sodium
chlorate to see the trend of beta of all firms in the market since we believe that such trend
can be a benchmark for calculating the beta of sodium chlorate for Dixons project.
The average beta is calculated from the formula: asset = equity / [1+ (1-t)*D/E], where
D is debt, E is equity and t is tax rate. To simplify the calculation, we assume that all these
firms have tax rate at 48% and debt is zero. The detailed calculation is provided in the
Appendix 1. From the table, we notice that the betas of 3 diversified chemical producers
American Chemical, Kerr-McGee and Int. Minerals and Chemicals (Ga is a paper company
and Pennwalt is a large diversified chemical producer) is less than the market beta (1.00).
We also observe that the two pure play firms (last 2 rows) have higher beta than the market
beta. Thus, sodium chlorate may have higher beta than other chemical products. Because
sodium chlorate is totally new to Dixon, we assume that Dixon plays the role of a pure
sodium chlorate producer and consider the average of the beta of Brunswick and Southern
as the beta for Dixon in this project. This beta is =1.09. The beta 1.09 seems more
reasonable as Dixon may have more risk to take the project than other companies who
already produce this product for a long time.
Now, Dixon needs to re-lever this beta by using its own target capital structure (35%, p.4).
The formula for re-levered beta is: levered equity = asset * [1+ (1-t)*D/E] = 1.09*[1+
(1-0.48) *0.35/0.65] = 1.40.

Weighted average cost of capital (WACC):

Cost of equity: in the case, the yield on T bonds is 9.5% (p.4). We assume that it is the risk
free rate. We use the historical equity risk premium 8.4% stated on the Table 9.2, page 247
of the textbook. According to the CAPM method, the cost of equity for this project is 9.5%
+1.38*8.4% = 21.26%.
Cost of debt: because there is little information about Dixons debt provided on the case, we
assume that all debt Dixon intends to borrow is used in the acquisition of Collinsville plant
at 11.25%. We also assume that debt is issued at par. The after-tax cost of debt is (10.48)*11.25% = 5.85%.
WACC: we use Dixons 35% target level of debt-to-asset ratio in acquiring the plant to
calculate cost of capital. WACC = D/V*After-tax cost of debt + E/V*Cost of equity =
0.35*5.85%+0.65*21.26% = 15.87% @ 16%. Therefore, the WACC for Collinsvilles plant
cash flow is nearly 16%. We use this cost of capital to calculate NPV of the project.
Calculating NPV
To calculate the NPV for the project we have observed two cases during the investment:
purchasing the plant without laminate technology and with laminate technology.
Without laminate technology
We have calculated NPV on the basis of the current cash flow provided in appendixes of
the case and information provided in case material. So we have used the data in Exhibit 8
and projected cash flow from 1980 to 1984, and we have calculated cash flow to 1989
based on our assumptions aforesaid. For further details please refer to Appendix 2.
It had resulted on NPV being negative 3,703 thousand USD.
With laminate technology
Case defines us some cost reductions and benefits such as graphite cost elimination, tax
benefits and power cost savings, since 2.25 million. USD worth of laminate technology is
bought and installed. So we had calculated additional NPV, which has derived from cost
savings and tax benefits we have out of buying the additional laminate technology. Our
assumption is NPV with laminate technology = NPV without laminate + NPV additional
savings.
From this approach we have calculated Additional NPV of 6,634 thousand USD in
Appendix 3.So NPV with laminate technology is -3,703+6,634=2,931 thousand USD.
Sensitive analysis
In order to see whether the project is viable in case of negative changes in variables, we
have conducted sensitive analysis having one of major variables such as sales growth rate,

which can be reflected by different reasons such as decrease in demand, production

slowdown, economic recession and etc. We have tried other possible valuables, but they
occasionally did not have much effect on the project outcomes.
We wanted to know what is the rate of growth rate should be in both cases (without and
with laminate technology) so that the company will have Zero NPV. Using Solver function
in Excel, we found that in case of Zero NPV without laminate technology sales growth rate
should kept up around 14% and with laminated technology growth rate should not go down
of around 2% level (Please see Appendix 4).
5. Strategic and economic benefits
Besides increasing shareholders wealth, company gets some strategic and economic
benefits, such as:
- Increase in product range- Larger market share in paper industry- Opportunities to enter
new market
- New market development and competition reduction
- Enhancement of relationships with current customers
- Development of new technology
By acquiring Collinsville plant, Dixon could complement its strategy of supplying
chemicals products to the paper and pulp industry. It can use the existing sales force to
market products to save selling costs. Dixon will add a new product in its existing product
mix.
Laminate technology would allow company to considerably cut power cost and completely
eliminate graphite costs. By gaining technological savvy, the company can use the same
practices in other plants and reduce production costs.
Company has developed the relationships with Collinsville existing customers. It is 6 more
times cheaper to retain existing customer than acquire a new one. Buying plant, company
will not incur potential marketing costs in initial selling of new products.
The company is better off buying the plant than building from the scratch a new one.
Usually, plants are costly to build. Also, the company can reduce competition in the market.
Buying a plant would be the best entry strategy for company. Building a plant would take a
year, and market is changing rapidly, so Dixon could lose market potential if it takes a long
time to build a new plant.
Laminate technology makes the Collinsville plant acquisition attractive on economic
grounds. In acquisition negotiation, Dixon should make a clause in the acquisition
agreement, which protects the Dixon in the case that the laminate technology fails to
produce the desired results. This clause should include that in thecae the laminate
technology fails, American Chemical Corporation should compensate Dixon for installation
charges.

Recommendations
Based on our analysis, we would like to make recommendations as follows:
Most fundamentally, a firm that is operating in the interests of its shareholders should try to
accept all projects that increase the wealth of the shareholders. In case of Collinsville, we
use NPV to approach to our recommendations.
Based on our calculation, without the laminate addition, the NPV of Collinsville turns out
to be negative (-3,703 thousand USD). Under this circumstance, we recommend not to
invest in this project since it is against shareholders interests.
But at the same time new Laminate Technology would allow company to considerably cut
power cost and completely eliminate graphite costs. Additional USD 2.25 million is needed
to install this new technology. We consider this technology as a subproject attached to
Collinsville and calculate its NPV. The NPV of this new technology is USD 6,634
thousand. That means, by using laminate technology, NPV of Collinsville will change to
USD 2,931 thousand. Under this new circumstance, our recommendation is to invest in
Collinsville because it will not only increase the wealth of the shareholders, but also
complement its strategy of supplying chemicals products to the paper and pulp industry.