American Chemical Corporation’s Collinsville plant in Alabama is being sought by Dixon a speciality chemicals company. This plant mainly specialises in Sodium Chlorate production and fits well with Dixon’s strategy of supplying chemicals to paper and pulp industry. It would also complement Dixon’s existing product line. The plant costs $12million in investment and requires up to$ 2.25 million for upgrading to new technology. An in-depth investigation and analysis is conducted for both the company and the industry to accurately determine the worth of investment in the Collinsville plant. Net present values are calculated for all possible scenarios. After a thorough analysis of the data, suitable recommendations are provided.
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 by acquiring the aforesaid plant, which produces sodiumchlorate to supply to paper producers in South-eastern 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.
About The Collinsville Plant
American Chemical Corporation’s plant in Collinsville had the capacity to produce 40000 tons of sodium chlorate per year. Sodium chlorate is produced via the electrolytic decomposition of salt, water and energy. The important factors for us to consider regarding sodium chlorate is where the demand for this chemical comes from. 85% of demand for the product is derived from the paper and pulp industry, where it is used in the production of the bleach that is used to whiten the paper. The remaining 15% comes from its use as a soil sterilant, in uranium mining and in the production of other chemicals.
Sodium Chlorate Market in USA
Bargaining Power of Customers * Customers include Paper & Pulp Producing Companies like Georgia Pacific and Universal * Because of high competition among the sodium chlorate producers, the bargaining power is being increased. * The demand is also increasing at the rate of 8 to 10% per year with extra usage in the plant effluent problems of paper corporations.| Competition within Industry * Highly Competitive Market * Market Leaders like Hooker, Pennwalt, American & Kerr-McGee have more than 55% of the US Market * Huge number of small medium enterprises with active shares in the sodium chlorate market in US * Paper Companies like Universal also have their own NaClO3 plants actively participating in the competition. * Companies like Brunswick and Southern are specialised only in NaClO3 production| Threat of New Entrants
* Union Chemicals and Lousiana Paper Company have already announced their entry into the competition with 40000 and 35000 tons plants respectively| Threat of Substitutes * Graphite Rods used in the production of NaClO3 are being replaced with Metal or Laminate rods. * This would eliminate graphite costs and also reduce power costs by approx. 30%| Issues surrounding Collinsville opportunity
1. Impact on revenues: Reduction in margins due to overcapacity: Although sodium chlorate prices were expected to increase, the overcapacity would cause number of tons to reduce (competition) and therefore, hit the margins. 2. Impact on costs: Increase of electricity from $0.019 in 1977 per kWh to $0.025 per kWh in 1979. Besides, due to upward revaluation of assets, depreciation was expected to increase. 3. Impact from adoption of technology: Depreciation would increase and Dixon was required to pay all costs related to the installation of laminated electrodes. 4. Impact of Financing of acquisition: Temporarily increase Debt to capital ratio to 47%. Target debt to capital ratio: 35% Valuation
The Next important step is the valuation of sodium chlorate plant i.e. Collinsville Plant for Dixon Company. The given values and assumptions are summarised in the following tables:
Using NPV Rule for the project – Without Laminated Electrodes
[Details of the expected values is given in Exhibit 1
As the table is clearly indicating the net present value is a negative value if the Collinsville Plant is valued assuming that the graphite rods are not substituted with the laminate ones. This project may not be profitable considering this negative value. Using NPV Rule for the project – With Laminated Electrodes
[Details of the expected values is given in Exhibit 2]
For calculating the NPV of project in case of Laminated Electrodes, the power costs are reduced by 20%. The Graphite costs are taken as zero since there is no utilisation of graphite in the newer technology. Also the capital expenditures for first year are taken as 2.5 million $(the cost of project). Now, the NaClO3 plant in Collinsville is valued using discounted cash flow assuming the plant would operate using new replaced laminate electrodes when they become available. In this project, it is founded out that the Net present value is positive suggesting the project is profitable if $2.25mn of laminate electrodes is included in the overall $12mn deal.
Calculations of Beta
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. The beta of Brunswick and Southern will be used to calculate the Beta un-leverd for the firm because the two firms purely produce sodium chlorate. Their Beta will be first unlevered. Then weighted average of those un-levered Betas will be used to calculate the levered beta of the firm.
For calculating levered Beta we take Dixons target capital structure (D/E ratio of 35%). Financing by the debt package will temporarily increase Dixon’s D/E ratio to .47. But we take .35 as the D/E ratio for calculation as the company will ensure that it maintains its target D/E ratio in the long run.
Monte Carlo Analysis
Monte Carlo analysis is used to gauge the sensitivity of free cash flows on the Net present value of the project. This is used to simulate various sources of uncertainty inherent in the cash flows. Monte Carlo Analysis is performed on both the relevant scenarios in the case and the variations are plotted in a graph.
For the Unlaminated factory
After installing lamination
Basing on our detailed calculations following recommendations are made to Dixon Corporation * The net present value (NPV) of Collinsville plant (without the lamination technology) comes out as -0.89 million. Since the NPV value is negative it is advisable not invest in this project and company should pursue other alternatives. * If the new Lamination technology is installed in the Collinsville plant then the Net present value comes out as $10.919 million. This is attributed mainly to the huge savings in power and graphite costs. Even though it requires a $2.5 million extra investment, the benefits far outweigh the costs.
Because of a high NPV value it is advisable to invest in the Collinsville plant and install the lamination technology. This investment will not only create synergies because of the similarity in the business but also add value to shareholders wealth. * If terminal values are taken as zero (assuming no residual value)then the NPV of Collinsville plant comes out as -$2.928 million. And after installation of lamination the NPV becomes as 3.6 million $. Because of the high NPV value in the later scenario it is advisable to implement advanced Lamination technology while investing in Collinsville plant.