American Chemical Corporation

Liquidation and Investment Analysis

Due on 10/24 prior to 11:30 AM

Instructions: Your group should upload one electronic copy of your Excel solution on Canvas.  You must upload your solution no later than 15 minutes before the start of the lecture on the day in which they are due. Late assignments will not be accepted. Ensure your solution contains your cluster and each group member’s name. You should submit a solution to all “Assignment

Questions” .  “Discussion  Questions”  are  designed  to  provoke  thought  and  will   be discussed in class but you do not need to address these in your assignment. Your solution should be formatted and set out so that it is easy to read, clearly show your working, the logic behind your answers, and any assumptions you made in the analysis.

You will be completing two analyses regarding the purchase of the Collinsville plant. You are being asked to make each decision at 31 December 19791 . In both scenarios the Collinsville plant will last through to the end of 1990 (11 years). Should Dixon continue in the sodium chlorate business after 1990 it will have to scrap the plant entirely and build a new one incorporating new technologies.

Assignment Questions

Question 1: Value the Collinsville plant as it stands with the unlaminated graphite electrodes. Using the following information to make your valuation:

a.    Extend management’s projections contained in Exhibit 8 through 1990 under the following assumptions (project only the additional items you need for the FCF calculation):

i.      The  plant  reaches effective capacity of 38,000 tons  in  1982.  Revenue  increases thereafter reflect only unit price increases. Revenue grows at  10% annually after 1984.

ii.     Power costs rise at 15% per annum after 1984.

iii.   Annual capital expenditures will be $500,000 in 1980, 1981, and 1982. From 1983 through to 1989 annual capital expenditure will be $600,000. No additional CAPEX will occur in 1990 as the plant closing approaches. See the note below on PP&E for further information.  iv. All capital expenditures are depreciated straight-line over 10 years.  (I have corrected  Exhibit 8 in the spreadsheet to  reflect this.  Use these corrected numbers). Depreciation of any capital equipment starts the year after it is purchased.

v.     The tax rate is 48% throughout.

vi.    With the above exceptions and the items they affect, after 1984 other items should be forecast to grow at the same rate as sales. In other words, these other items are expected to maintain the same ratio to sales from 1984 onwards.

b.   Estimate free cash flows for each year 1980-1989.

c.    Estimate the free cash flows in 1990. This will include the free cash flow from operating the plant in 1990 and the cash flow consequences of shutting down the plant at the end of the year. Assume account receivables will be liquidated at 100% of its 1990 book value, inventory at 75% of its 1990 book value2  and PP&E at 0%. Treat the tax consequences of book losses of the liquidation of all these assets in the same way we treat book losses of PP&E so that any book losses (i.e. the difference between liquidation value and book value) can be used to lower taxable income3 . Assume that Dixon will have enough taxable income and capital gains from its other operations so that the tax benefits of the book losses on all assets can be used right away in 1990 at the 48% tax rate. Assume that accounts payable will be paid in full in 1990.

d.   Estimate Dixon’s opportunity cost of capital for acquiring the Collinsville plant? Assume management’s target debt ratio (i.e. ND/(ND+E)) for the Collinsville plant is 15%. Use this ratio for your WACC calculation. Disregard the information on the second last paragraph about the proposed financing of the deal. For the cost of debt use 11.25% (we will discuss this number in class). Information on potential comparable firms is provided in Exhibits 1, 2 and 5. You should choose which firms to use and justify your choice.4  Footnote 2 of the case reading provides information regarding the yield curve. Within that footnote, “Short- Term” refers to a 1-year yield and “Long-Term” refers to a 10-year yield.

Without the electrode upgrade, do you recommend purchasing the Collinsville plant at the asking price of $12 million?

Question 2: Value the Collinsville plant with the updated laminated electrodes.

The electrode update will occur in December 31 1980. It will cost $2.25 million (i.e. this is additional Cap Ex paid at December 31 1980). This cost will be depreciated straight-line over 10 years. It is estimated that once installed, the upgrade will eliminate all graphite costs and will cut power costs by 17.5% (i.e. starting in 1981). These cost savings from the upgrade will last until the plant abandonment at the end of 1990. As with the rest of PP&E, assume that the upgrade has zero value in liquidation.

All other information about the plant remains the same as in Question 1.

Do you recommend that Dixon pays the $2.25 million to upgrade the Collinsville plant?

Do you recommend the purchase of the Collinsville plant for $12 million with the anticipated electrode update in 1980?

Note on PP&E

Exhibit 6 shows expected PP&E at the end of 1979 for the Collinsville plant of 4,014. However when Dixon buys the plant these assets appear in Dixon’s balance sheet (Exhibit 8) at 10.6M (plant “write up” as per footnote 1 in the case reading). This 10.6M is the amount that will be depreciated straight line over the next 10 years starting in 1980.Additional depreciation (i.e. over the 1,060) that appears in Exhibit 8 in the following years (e.g. 1,110 in 1981, 1,160 in 1982 etc) is due to the additional capital expenditure in each year.

Discussion Questions (No Submission Required)

1.   Suppose Dixon can borrow to finance the entire asking price of $12 million at 11.25%, would it make sense to use this number as the cost of capital for the acquisition? Explain.

2.   What if American Chemical’s laminate research doesn’t pan out? What do you think is the problem with a deal that requires full payment initially? How could the deal be structured?

3.   How should your valuation capture the risk of the laminate research not being successful?