Du Pont Case Study

E. I. du Pont de Nemours and Co.:

Titanium Dioxide

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Executive Summary

        E. I. du Pont de Nemours and Co. (Du Pont) is a leading manufacturer of fibers, plastics, industrial chemicals, and other specialty chemicals.  The company is organized into 10 industrial departments.  The pigments department, the second smallest, was responsible for titanium dioxide.  Titanium dioxide is a white chemical agent used in the manufacturing of paints, paper, synthetic fibers, plastics, ink, and synthetic rubber.  There are two main processes that exist for manufacturing titanium dioxide, a sulfate process and a chloride process.  Between 1969 and 1972, two major events altered the titanium dioxide market.  First, a sudden shortage of rutile ore (used in developing titanium dioxide) developed in 1970 and 1971, resulting in ore prices rising dramatically.  Additionally in the same period, sulfate process plants were forced to make major capital expenditures to comply with the new environmental protection legislation.  This resulted in Du Pont’s ilmenite chloride process creating a substantial cost advantage gap in Du Pont’s favor.  

Because of the excess demand created in Du Pont’s favor, this created opportunities for capacity expansion.  The executive committee of E. I. du Pont de Nemours and Co. had to decide whether to pursue a conservative strategy (maintain strategy) or to pursue a more aggressive strategy going forward (growth strategy).  

Du Pont should pursue the growth strategy because it provides the greatest value to the firm going forward.  The growth strategy has a higher NPV value ($55.26 million) than the maintain strategy ($25.37 million).  While the growth strategy is more promising, the company has to take into effect that if the discount rate is above 12.76%, then they must reconsider its forward-looking strategy.  

Key Facts

Du Pont’s marginal tax rate in 1972 was 48%.  In 1972, long-term Treasury bonds yielded 6.2%, Aaa corporate bonds yielded 7.2%, Baa yielded 7.8%, and inflation was 3.2%.  The market share is expected to be 45% and 65% after implementing either the maintain strategy or the growth strategy respectively.  The cost of new capacity is expected to be $900 per ton in 1973.  Capital investments (excluding additions to net working capital) would be eligible for a 10% tax credit.  

Maintain Strategy

The maintain strategy is the conservative approach.  It sets a goal to boost Du Pont’s market share in titanium dioxide to 45% over the next few years.  This strategy keeps capital expenditures expansion at a much lower volume than the growth strategy.  By keeping debt levels low, this results in a cleaner income statement and balance sheet.  However, total capacity and future development will be limited with market share being maintained at 45%.  

Growth Strategy

The more aggressive option is the growth strategy.  This strategy projects to capture 65% of the market share.  The investment would require capital expenditures that would reach $500 million by 1985.  Because of the increasing demand for titanium dioxide, this will help the company gain larger profits and be able to better finance its capital expenditures.  The growth strategy requires expanding capacity through 1985, lower pricing for titanium dioxide, and restricting the licensing of the ilmenite chloride process to improve the company’s competitive position.

Statement of the Problem

The executive         committee must decide whether to stay conservative and implement the maintain strategy, or take advantage of the current industry conditions and assert the growth strategy going forward.  The committee must project the cash flows, calculate the NPV, and IRR for each strategy as well as perform sensitivity.  Additionally, the committee has to factor in possible delays and difficulties with the aggressive growth strategy.

Analysis

        Du Pont has several competitive advantages over its competitors as of 1972.  Due to recent environmental protection legislations, this has made titanium dioxide production costs increase for sulfate processing plants.  Additionally, a shortage of ore developed over the past several years and raised the price of ore dramatically.  Because Du Pont had mostly used an innovative ilmenite chloride process, this resulted in a substantial competition gap over its competitors, having its process become much cheaper than the sulfate process.

        To determine an appropriate discount rate, I utilized the specialty chemical industry cost of capital, according to the “Cost of Capital by Sector (US)” paper at the New York University Stern School of Business.  The discount rate is 7.22%.  I used this discount rate because this described the industry’s average cost of capital for this product.  Using this hurdle rate, the NPV under the maintain strategy (Figure 1) is $25.37 million.  Under the growth strategy (Figure 2), the NPV is $55.66 million.  The growth strategy has a higher NPV than the maintain strategy at this current hurdle rate.  However, if the cost of capital is actually higher than 12.76% (Figure 3), then the maintain strategy will have contain a higher NPV.  The Internal Rate of Return (IRR) for the maintain strategy and growth strategy are 14.62% and 13.49% respectively (Figure 3).  

        If Du Pont decides to proceed with the maintain strategy, there is some risk associated with losing market share in the future.  Some competitors may react positively to the recent changes in the titanium dioxide market, motivating them to create a more cost effective process or possibly eventually copy Du Pont’s current chloride technology.  

        If Du Pont pursues the growth strategy, its competitors may gain market share by developing a new, cost effective process that will surpass the efficiency of Du Point’s ilmenite chloride process.  Another possible risk that is that as Du Pont continually increases market share, possible antitrust legal issues may arise.

Some other factors to consider is the possible volatility of ilmenite ore prices.  This may alter future production levels or demand of titanium dioxide.  Additionally, there are risks associated with delayed startups and technical difficulties from titanium dioxide operations.  Further, there is a possibility tariffs on titanium dioxide imports will be lowered, increasing competition from the international markets.  Another concern include inflation rates, in 1972 being 3.2%.  If the titanium dioxide industry grows only 3% a year, then the real rate of return (0.19%).  Additionally, the company may have other better opportunities for investment in other departments, since they primarily rely on retained earnings for its capital expenditure programs.

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