Case: American Chemical Corporation

1834 Words Dec 2nd, 2011 8 Pages
1. 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 sodium-chlorate to supply to paper producers in Southeastern part of the US. This plant initially cost 12 mln. USD and additional 2,25 mln. USD 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
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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: βlevered equity = βasset * [1+ (1-t)*D/E] = 1.09*[1+(1-0.48) *0.35/0.65] = 1.40.

b. Weighted average cost of capital (WACC):

Cost of equity: in the case, the yield on Tbonds 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 Dixon’s 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 (1-0.48)*11.25% = 5.85%.

WACC: we use Dixon’s 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 Collinsville’s plant cash flow is nearly 16%. We use this cost of capital to calculate NPV of the project.

3. 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

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