Dixons Purchase on Collinsville: The Victory of Laminate

Report for
Dixon Corporation: The Collinsville Plant

Yangfan Chen 113710773

Ruoping Lin 113661082
Yue Lin
113738890
Ren Wang
113852749

Dixons Purchase on Collinsville: The Victory of Laminate

Dixon has an opportunity to buy Collinsville plant, a plant used to produce sodium
chlorate (NaClO3). With Collinsville, Dixon can therefore complete its production
chain of chemicals used in paper and pulp industries. But the price American charged,
$12 million, seems to be relatively high. However, in fact, the relatively high price
can be regarded as an appreciation brought by new technology and relative services.
Therefore, Dixon should purchase Collinsville and pay for the laminate in 1980.
A reasonable WACC for Collinsville
First of all, we need to get a reasonable estimation of the projects debt ratio. We
assume that Dixon will keep the projects debt ratio the same as the entire companys
debt ratio. Plus we assume that the market value of debt equals to book value, because
over 85% of the debt is newly added. Therefore, the debt ratio is 16.99%. This value
can be verified by the mean debt ratio, 18%, of Brunswick Chemical and Southern
Chemicals, who run their business only in sodium chlorate production.
Secondly, we calculate the market premium data using weekly market premium data
from June 1974 to June 1979 collected by Fama and French. The market premium is
4.512% (Appendix 1).
Thirdly, the cost of debt is 11.25%. Therefore, using the return of long-term treasury
bonds, 9.5%, as risk free rate, we get the beta of debt, 0.388. For the beta of unlevered
equity, we use the mean unlevered equity of Brunswick Chemical and Southern
Chemicals. Plus, for Brunswick Chemical and Southern Chemicals, we assume that
their beta of debt is 0, because they may get loan in other ways. Therefore we get the
unlevered beta of sodium chlorate production industry, 1.033. Together with Dixons
beta of debt and debt ratio, we get the beta of equity, 1.165. Then, using CAPM
model, the cost of equity is 14.76%.
Finally, using the data in 1979, we calculate the tax rate of Dixon, 48.69%. Therefore,
with the debt ratio, cost of debt, cost of equity, and tax rate of Dixon, we get the
WACC of the whole project, 13.23%.
Can Collinsville generate positive NPV without laminate?
Since Dixon has made prediction for the financial data from 1980 to 1984, we can
calculate the project NPV without laminate just with a few simple assumptions.
Except for the growth rate of sodium chlorate and power cost being 8% and 12%
respectively, we assume that the growth rates of graphite, salt and other, labor,
maintenance, other, and selling are 6.5%, 5.6%, 10%, 10%, and 0.7% respectively.
Besides, the other cost in fixed cost is $1,150,000 per year. So we can get the EBIT of
each year from 1980-1989 (Appendix 2).
We assume that the capital expenditure is used to renew the plant, and will be
depreciated over 10 years in straight line method. Therefore, the new plant value at
the end of each year should be the value of plant at the beginning of each year minus
depreciation of the original plant, plus capital expenditure, and minus the depreciation
of capital expenditure (Appendix 3).
Therefore, we can get the free cash flow of each year (Appendix 4) and calculate the

NPV of the whole project, which is -$956580.

Is Laminate worthy of the additional payment?
The laminate technology should be the main reason why American charges Dixon for
more fee on Collinsville plant than it should be. If the whole project plus laminate can
generate positive NPV under the most conservative estimation, then Dixon will have
enough reason to take the project and accept the relatively high purchasing price.
To calculate the free cash flow of the project with laminate, we assume that the power
cost can be saved by 15% per year, which is the lowest value of Dixons estimation.
Therefore, we get the operating profit of Collinsville in each year from 1980-1989
(Appendix 5). Then we can calculate the free cash flow in each of these years
(Appendix 6). Finally we get the NPV of the whole project, $4,213,350. Since the
project plus laminate generate positive NPV, it seems that Dixon has no reason to
refuse the project.
What if the situation changes?
There are three factors that we think may change, debt ratio, market premium, and
power cost. Therefore we conduct sensitivity analysis for these three factors
respectively (Appendix 7).
For debt ratio, we are worried about what if it decreases, because when it increases,
the NPV will be greater. In the sensitivity analysis, even when debt ratio is 0, the
project plus laminate generate positive NPV.
For market premium, since from June 1974 to June 1979, the average weekly market
premium of S&P 500 was negative, we may underestimate the market premium for
the evaluation. When we increase the market premium to 8%, the NPV is nearly 0.
However, 8% would be relatively too large for market premium. So we can still
conclude that Dixon should take the project with laminate.
For the power cost, we are worried that the energy crisis may raise the power price,
leading to underestimation of power cost. We change the power price as a whole
while keep the 12% annual growth constant. When the power price increases by a
little over 15%, the project NPV runs close to 0. We consider that the energy crisis
may not last for 10 years, so there is little chance that the power price for the 10 years
will increase by over 15%. Therefore, Dixon still has the incentive to take the project.
Appendix 1
The formulation used to calculate market premium
Market Premium = (1 + 9.5%/52 + Mkt-Rf/262)52 1 9.5%
where Mkt-Rf is the weekly market premium over the past five years.
Source of Mkt-Rf:
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

Appendix 2 Income Statement of Collinsville Plant without Laminate

Revenues
Sales-tons
Average price/ton
Sales - $000
Manufacturing costs
Variable - Power

1980

32,000
$415

1981

35,000
$480

1982

38,000
$520

1983

38,000
$562

1984

38,000
$606

$13,280

$16,800

$19,760

$21,356

$23,028

$6,304

$7,735

$9,386

$10,526

$11,780

645

791

875

940

992

1,285

1,621

1,753

1,836

1,956

$8,234

$10,147

$12,014

$13,302

$14,728

$1,180

$1,297

$1,427

$1,580

$1,738

256

277

299

322

354

1,154
$2,590

1,148
$2,722

1,179
$2,905

1,113
$3,015

1,153
$3,245

$10,824

$12,869

$14,919

$16,317

$17,973

$112

$125

$138

$152

$168

451

478

508

543

591

$1,060
$1,623

$1,110
$1,713

$1,160
$1,806

$1,210
$1,905

$1,270
$2,029

1985

- Salt & Other

Total variable
Fixed - Labor
- Maintenance
- Other
Total fixed
Total manufacturing
costs
Other charges
Selling

Depreciation
Total

1988

1989

1056.48
2065.53
6
16315.6
2

38000
706.838
4
26859.8
6

14776.8
3
1125.15
1
2181.20
6
18083.1
9

1911.8

2102.98

38000
763.385
5
29008.6
5

16550.0
5
1198.28
6
2303.35
4
20051.6
9
2313.27
8

389.4
1150

428.34
1150

3451.2
19766.8
2

3681.32
21764.5
1

170.360
2
620.919
4
1390

38000
824.456
3
31329.3
4

18536.0
6
1276.17
5
2432.34
1
22244.5
7
2544.60
6
518.291
4
1150
4212.89
7
26457.4
7

172.753
6
652.353
4
1510
2335.10
7

38000
890.412
8
33835.6
9

20760.3
9
1359.12
6
2568.55
2
24688.0
6
2799.06
6
570.120
5
1150
4519.18
7
29207.2
5

173.962
9
668.662
3
1570
2412.62
5

38000
654.48
24870.2
4

169.176
R&D

1987

13193.6
- Graphite

1986

605.775
1330
2104.95
1

2181.28

471.174
1150
3934.45
2
23986.1
4

171.552
8
636.442
4
1450
2257.99
5

Operating Profit

$833

$2,218

$3,035

$3,134

$3,026

2998.47
3

2914.07

2764.50
9

2536.76
1

2215.81
1

Appendix 3 The Plant Value, Capital Expenditure, and Depreciation in Each Year from 1980 to 1989

PPE(beginning of the
year)
Depreciation
CapEx
DepWithNewCapEx
Net PPE

Total Depreciation

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

10600
1060
500
0
10040

10040
1060
500
50
9430

9430
1060
500
100
8770

8770
1060
600
150
8160

8160
1060
600
210
7490

7490
1060
600
270
6760

6760
1060
600
330
5970

5970
1060
600
390
5120

5120
1060
600
450
4210

4210
1060
600
510
3240

1060

1110

1160

1210

1270

1330

1390

1450

1510

1570

CapEx used to renew the PPE and the renewed part will be depreciated in straight line method for ten years.
Since the data in Dixon's prediction doesn't match, use the total depreciation as the standard to calculate the Capital expenditure in each year. We
also assume that the CapEx after 1983 will stay $600000

Appendix 4 Free Cash Flow for Collinsville Project without Laminate


EBIT

1979

Tax

48.69%

1980

1981

1982

833.00

2218.00

3035.00

405.59

1079.94

1477.74

427.41

500.00
1060.0
0

1328.0
0
598.00

1138.06

500.00

1557.26

500.00

1110.00

1680.00

1160.00

1976.00

756.00

889.00

924.00

1087.00

1512.00
316.00

1778.00
266.00

1951.26
1280.90
8
3232.17

NI

CapEx

Depreciation

A/R
Inventory

A/P

NWC
NWC

FCF

730.00
1196.0
0
-204.00

1191.4
1

Discount
Rate

1432.06
1110.73
9

2542.79

Terminal
Value
PPE*T
NWC
TV
PV-TV

1400

13.23%

1611.64
3044
4655.64
$1,308.80

1983
3134.0
0
1525.9
4
1608.0
6

600.00
1210.0
0

2136.0
0
961.00
1175.0
0
1922.0
0
144.00

2074.0
6
1402
3476.0
6

1984

1985

1986

1987

1988

1989

3026.00

2998.47

2914.07

2764.51

2536.76

2215.81

1473.36

1459.96

1418.86

1346.04

1235.15

1078.88

1552.64

600.00

1538.52

600.00

1495.21

600.00

1418.47

600.00

1301.61

600.00

1136.93

600.00

1270.00

2303.00

1330.00

1390.00

1450.00

1510.00

1570.00

1036.00

2487.24
1118.88

2686.22
1208.39

2901.12
1305.06

3133.21
1409.47

3383.86
1522.22

1267.00

1368.36

1477.83

1596.06

1723.74

1861.64

2072.00
150.00

2237.76
165.76

2416.78
179.02

2610.12
193.34

2818.93
208.81

3044.45
225.51

2072.64
1525.19
5

2102.76
1667.07
8

2106.19
1824.16
6

2075.13
1998.16
8

2002.80
2190.98
5

1881.42
2404.74
3

3597.84

3769.83

3930.36

4073.30

4193.79

4286.16

Appendix 5 Income Statement of Collinsville Plant without Laminate

1980

Revenues
Sales-tons
Average price/ton

32000
415

Sales - $000

13280

1981

1982

6304

- Graphite
- Salt & Other

645
1285

Total variable

8234

Fixed - Labor

1180

- Maintenance

256

38000

480

520

562
23028

19760

7978.1
0

8947.1
0

1621

1753

1836

9731.1

451

1427

1580

1987

277
1148

299
1179

322
1113

2722

2905

3015

1153
3245

38000
763.385
5
29008.6
5

14067.5
4
0
2303.35
4

13280.1

38000
706.838
4
26859.8
6

12560.3
1
0
2181.20
6
14741.5
1

1911.8

2102.98

389.4
1150

428.34
1150

3451.2

3681.32
18422.8
3

170.360
2
620.919
4
1390
225
1615

38000
824.456
3
31329.3
4

15755.6
5
0
2432.34
1
18187.9
9
2544.60
6
518.291
4
1150
4212.89
7
22400.8
9

172.753
6
652.353
4
1510
225
1735
2560.10
7
6368.34
5

38000
654.48
24870.2
4

11214.56
0
2065.53
6

15214

12636.1

13798.1

138

168
152

16731.3

169.176

591
478
1110
225
1335

508
1160
225
1385

543
1210
225
1435

1938

2031

2130

833

1270
225
1495
2254
5560

3944.25

5092.9

5427.9

1988

16370.9
2313.27
8

354

125
1060

1060
1623

1986

1738

10917.75

R&D

0
1956

10783.1

10824

112

Operating Profit

10013

1985

11969

1154
2590

Other charges
Selling

Depreciation-PPE
Depreciation-Laminate
Total Depreciation
Total

21356

6574.75
0

1297

Total manufacturing costs

38000
606

38000

8195.75

- Other
Total fixed

1984

35000

16800
Manufacturing costs
Variable - Power

1983

605.775
1330
225
1555
2329.95
1
5808.99
3

2406.28
6030.74
6

471.174
1150
3934.45
2
20305.3
5

171.552
8
636.442
4
1450
225
1675
2482.99
5
6220.30
3

1989

38000
890.4128
33835.69

17646.33
0
2568.552
20214.88
2799.066
570.1205
1150
4519.187
24734.07

173.9629
668.6623
1570
225
1795
2637.625
6463.995

Appendix 6 Free Cash Flow for Collinsville Project without Laminate

EBIT
Tax
NI

CapEx
Depreciation

A/R
Inventory
A/P
NWC
NWC

1979

48.69%

1400

FCF

Terminal
Value
PPE*T
Laminate*T
NWC
TV
PV-TV

1611.64
109.55
3044
4874.74
$1,339.60

1980
833.00
405.59
427.41

500.00
1060.00

1328.00
598.00
730.00
1196.00
-204.00
2250.00
1058.59

1981
3944.25
1920.46
2023.79

500.00
1335.00

1680.00
756.00
924.00
1512.00
316.00

1982
5092.90
2479.73
2613.17

500.00
1385.00

1976.00
889.00
1087.00
1778.00
266.00

1983
5427.90
2642.84
2785.06

600.00
1435.00

2136.00
961.00
1175.00
1922.00
144.00

1984
5560.00
2707.16
2852.84

600.00
1495.00

2303.00
1036.00
1267.00
2072.00
150.00

1985
5808.99
2828.40
2980.59

600.00
1555.00

2487.24
1118.88
1368.36
2237.76
165.76

1986
6030.75
2936.37
3094.38

600.00
1615.00

2686.22
1208.39
1477.83
2416.78
179.02

1987
6220.30
3028.67
3191.64

600.00
1675.00

2901.12
1305.06
1596.06
2610.12
193.34

1988
6368.34
3100.75
3267.60

600.00
1735.00

3133.21
1409.47
1723.74
2818.93
208.81

1989
6464.00
3147.32
3316.68

600.00
1795.00

3383.86
1522.22
1861.64
3044.45
225.51

2542.79

3232.17

3476.06

3597.84

3769.83

3930.36

4073.30

4193.79

4286.16

Appendix 7 Sensitivity Analysis

initial

NPV-Collinsville
-2389.99

NPV
project
2426.09

initial value=16.99
debt ratio=15%
debt ratio=10%
debt ratio=5%
debt ratio=0

initial value=4.5%
when Market premium=6%
when Market premium=7%
when Market premium=8%
when Market premium=9%

initial value=
when power cost increase by 5%
when power cost increase by 10%
when power cost increase by 15%
when power cost increase by 20%

-2466.08
-2653.47
-2835.35
-3011.94

2287.69
1947.25
1617.39
1297.70

-2993.40
-3367.26
-3717.96
-4047.3

1331.23
656.17
25.4
-564.58

-3159.39
-3928.79
-4698.19
-5467.58

1656.70
887.3
117.90
-982.73