Dixon Corporation: Collinsville Plant Valuation

Dixon Corporation: Collinsville Plant Valuation

American Chemical was one of the largest diversified chemical company in the United States. To seek regulatory approval of acquiring Universal Paper Corporation - a large paper and pulp company, it agreed to divest its sodium chlorate plant - Collinsville plant in 1979. Collinsville was then sold to Dixon Corporation for $12 million. The valuation of Collinsville under WACC approach consists of two parts. First, we conduct a valuation on Collinsville plant without the laminate technology (the status quo before potential acquisition). Second, we evaluate the NPV of the laminate technology to understand whether it makes financial sense for Dixon to deploy this technology should the company decide to follow through the acquisition. To begin the valuation, we calculate WACC by analyzing and estimating the cost of equity, cost of debt and the associated capital structure. Specifically for cost of equity, we will break down our analysis into discussions about risk free rate, market risk premium and beta in the following paper. We will then apply the WACC to  discount the projected free cash flow from 1980 to 1989 for Collinsville with and without the technology to arrive at the valuations.

WACC (11.52%)

Capital Structure

We assume that Dixon will finance the acquisition with 100% debt and Dixon’s post-acquisition D/E ratio will therefore be 30%. As we will see in the analysis of cost of equity below, financing with debt turns out cheaper than with equity. Furthermore, Dixon has the capacity to raise this level of debt given its past performances. So it makes sense for Dixon to use debt in this case.

Cost of Equity

To estimate cost of equity, we use the long-term treasury bond interest rate (9.5%) at the time as risk free rate. According to our research,  the arithmetic average annual return of S&P 500 between 1950 - 1979 is 12.35%. Therefore we proceed to assume the market risk premium as 3% for simplicity. To calculate the beta, we first argue that Dixon’s beta is not applicable to Collinsville’s case due to the differences in their businesses and the risks associated with those businesses.. Dixon is a company that produces a selection of special chemicals whereas Collinsville specifically produces one type of chemical. A similar argument can be made about Pennwalt, Kerr-McGee, International Minerals and Chemicals and Georgia-Pacific given their diversified product portfolio. So we choose Brunswick Chemical Company and Southern Chemicals alone as the comparables for Collinsville because both of them specialize in sodium chlorate. We assume comparables have the same tax rate as Dixon (48%). We also assume Dixon's and comparables' debt is risk free, i.e. debt beta = 0. Then we calculate the average unlevered beta of Brunswick Chemical Company and Southern Chemicals and relever the beta according to Dixon’s capital structure to get beta = 1.26 .

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Therefore, the cost of equity is equal to 13.27%.

Cost of Debt

We assume that after financing the acquisition with debt, Dixon’s bond rating will remain at A which leads to its cost of debt at 10.75%.

All things considered, the WACC for the valuation is equal to 11.52% as calculated below.

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Free Cash Flow Projections and Valuations

Collinsville Plant Without Laminate Technology

To build pro forma financial statements from 1985 to 1989 and calculate the value of Collinsville plant without the laminate technology, we assume:

1. The plant’s production capacity caps out at 40,000 so we project sales volume to grow to 40,000 tons and remain constant for the 5 years after 1984.
2. Per case, sodium chlorate prices are expected to grow at 8% per year so prices will increase 8% each year.
3. Per case, power rates are projected to increase 12% per year.
4. The graphite, Salt & Other, Labor, Maintenance and Other costs will remain the same % of sales as 1984 throughout 1985 - 1989. The same applies to Selling and R&D charges.
5. Depreciation follows a straight-line method over 10 years per the case and will increase by 60k per year after 1984 due to trend of previous years. The plant will be out of use after 10 years so there will not be any terminal value estimate associated with the valuation.

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To calculate free cash flow and NPV without the laminate, we assume:

1. Previous years tax rate for Dixon equated to roughly 48% so this is the tax rate we use going forward.
2. Capex was expected to be between 475-600k per year so we used the average of 537.5k
3. For working capital, account receivables and inventory each year will remain the same percentage of Revenues as 1984. Account Payable will remain the same percentage of total manufacturing costs as 1984.

[pic 4]So, if Dixon should proceed to acquire Collinsville with $12 million, the NPV of the acquisition will be $-1.32 million. In other words, Collinsville plant without laminate technology should be valued at $10.68 million instead.

Collinsville Plant With Laminate Technology

To evaluate the investment of installing laminate electrodes, we make the following assumptions and conduct the NPV analysis accordingly.

1. The upfront installation cost equals 2.25 million at Dec. 1980, with a straight-line depreciation over 10 years and no salvage value.
2. The laminate will reduce power needs by 17.5% between 1980 and 1989.
3. The laminate will eliminate graphite cost between 1980 and 1989.
4. No capex for deployment of laminate except upfront installation cost.
5. All other assumptions in previous pro forma hold for this valuation, including same WACC for discount and no change in net working capital.

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So implementation of laminate technology will generate a positive NPV of $7.75 million in 1980, equivalent of $6.95 million if discounted to 1979 year end.  

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