See

discussions, stats, and author profiles for this publication at: https://www.researchgate.net/publication/235700006

American Chemical Corporation: Financial

Analysis
Chapter June 2010

READS

5,237

1 author:
Bilal al Qureshi
University of Oxford
6 PUBLICATIONS 0 CITATIONS
SEE PROFILE

Available from: Bilal al Qureshi

Retrieved on: 19 August 2016

Bilal Al- Qureshi, Said Business School, University of Oxford 2010

American Chemical Corporation

HBS Case Number: 9-290-102
Executive Summary
The American Chemical Corporation (AMC) is a large, diversified chemical producer. In 1979,
AMC was forced to issue a tender to sell a Sodium Chlorate plant, near Collinsville, Alabama.
Dixon, a specialty chemicals company, was willing to purchase the aforementioned plant for
$12m with the option to invest a further $2.25m on laminate technology. The subsequent
investment in Laminate technology was expected to eliminate graphite costs and reduce power
consumption at the Collinsville plant by 15% to 20%.
We will evaluate the acquisition of the Collinsville by Dixon at the proposed price.
Table 1 identifies the assumptions that have been used for the evaluation of this acquisition.
Table 1
Assumptions

Reference

Laminate Technology reduces power by a

mean of 17.5%
Laminate Technology is depreciated over 10
years
Sodium Chlorate price growth is 8%, per
annum
Power cost (per KWH) growth is 12%, per
annum
Plant Life is 10 years

Pg 3, HBS 9-280-102

Plant Salvage Value is zero

Pg 1, Assessed work Sheet

EBIT is flat after 1984

Pg 1, Assessed work Sheet

Capital Expenditures: $600,000 per annum

after 1984
Net Working Capital Remains flat after 1984

Pg 1, Assessed work Sheet

Definition of Flat

Pg 4 http://www.imf.org/external/pubs/ft/wp/2006/wp06218.pdf

6.5% is the Equity Risk Premium

Slide 21, Risk and Return, class notes-

Tax rate is 48.69%

http://www.investopedia.com/articles/04/012104.asp
Exhibit 7, HBS 9-280-102

Pg 3, HBS 9-280-102
Pg 4, HBS 9-280-102
Pg 4, HBS 9-280-102
Pg 1, Assessed work Sheet

Pg 1, Assessed work Sheet

From 1984 to 1989, the following growth

rates are used

Exhibit 8 , HBS 9-280-102

4 year Growth rate is used for Variable Costs

Capital investment is based on figures from
1980-1984
PPE and depreciation is based on figures
from 1980-1984

Exhibit 8, HBS 9-280-102

Beta Debt is zero

Pg 443, Demarzo 2007

Debt to Equity Ratio: 35% : 65%

Plant: Valuation starts in 1980
Laminate Tech valuation starts in 1981

Pg4, HBS 9-280-102

Exhibit 8, HBS 9-280-102

Exhibit 8, HBS 9-280-102

Bilal Al- Qureshi, Said Business School, University of Oxford 2010

1. Estimate the Cost of Capital

Reference: Q1.ACC.SBS.xls
a. Dixon Beta
Exhibit 5 identifies the Equity Betas of selected Sodium Chlorate producers. Exhibit 7
identifies a beta of 1.06 for Dixon. However, as previously stated, Dixon is not currently a
Sodium Chlorate producer thus the suggested Beta fails to provide an insight into the
systematic risk of the project vis--vis the sodium chlorate industry.
We decide against calculating, and thus using the average equity beta of Southern and
Brunswick as market representatives, as the cited chemical producers account for 5% of the
Southern Eastern US market.
We therefore, calculate the average beta of the sodium chlorate industry by delevering the
equity beta of market participants, as identified in Exhibit 7.As a noted market participant; we
include American Chemical Corporation (ACC) in our calculations.
Specification 11 identifies the formula used to delever:
(1) U = ((EQ/EV) * E ) +(( DV/EV) * E)
Table 2 presents our findings
Table 2
1978
Equity
Debt
Tax rate
E
D
U

ACC
PW
0.61
0.69
0.39
0.31
48.7% 48.7%
1.20
1.33
0
0
0.73
0.92

KM
1
0.00
48.7%
1.06
0
1.06

IMC
0.99
0.01
48.7%
0.81
0
0.80

GP
0.71
0.29
48.7%
1.5
0
1.07

BC
0.85
0.15
48.7%
1.1
0
0.94

SC
0.79
0.21
48.7%
1.2
0
0.95

Based on the figures extracted from Exhibit 1 & 5, a mean U of .92 is yielded, suggesting that
the related business operations of the selected market participants is less volatile than the
market thus, in the absence of leverage, the sodium chloride industry has the traits of being
low risk / return.
U is then accordingly adjusted by being factored by Dixons capital structure.
Specification 22 identifies the formula used to relever and adjust U with Dixons capital
structure.
(2) Dixon Beta D= ( 1 + D/E ) * BU
1.42= ( 1 + .35/.65) *.92

1
2

Pg 637, 2007, Demarzo, P et al Corporate Finance, Pearson International

Pg 443, 2007, Demarzo, P et al Corporate Finance, Pearson International
3

Bilal Al- Qureshi, Said Business School, University of Oxford 2010

b. Cost of Debt (CoD)

Dixon is raising debt capital by issuing long3 and short term bonds; an interest rate of
11.25% is used, for both instruments.
Specification 3 identifies the formulae to calculate the cost of debt.
(3) COST OF DEBT = (1-t)* Mrf
5.77% = (1- 48.49%) * 11.25%
c. Cost of Equity (CoE)
We use the Capital Asset Pricing Model (CAPM) to determine the cost of equity. As
per our assumptions, our equity risk premium4 is 6.5%. Our Risk Free rate (Rf) is
determined by the yield of a long term government treasury bond, 9.5%
Specification 4 identifies the formulae to calculate the cost of equity.
(4) CoE = Rf * D* ERP
18.73% = 9.5% * 1.42 * 6.5%
d. Weighted Average Cost of Capital (WACC)
As per our assumptions the debt structure juxtaposed with the equity structure is 35%:
65%.
The CoD calculation factors in the effect of taxation thus,
Specification 5 identifies the formulae to calculate the tax adjusted WACC
(5) WACC = (Ds)*CoD + (Es)*CoE
14.19% = (35% * 5.77%) + ( 65% * 18.73%)
The pre-tax adjusted WACC is 15.94% nonetheless; for the purpose of valuation we
will use 14.19%
e. Cost of Capital, Unlevered
In order to remain prudent, we use 6.5% as the ERP, and 9.5% for the Rf
Specification 6 identifies the formulae5 to calculate the unlevered cost of capital
(6) RU = Rf + BU * ERP
15.48 % = 9.5% + (.92 * 6.5%)
Thus the unlevered cost of capital, which can be used for APV analysis6, is 15.48%
3 We understand Long Term to be 15 years or more: http://www.businessdictionary.com/definition/long-termbond.html
4 The Equity Risk Premium is typically between 4% - 7% http://www.investopedia.com/articles/04/012104.asp
5 The formulae for the unlevered cost of capital is determined from Pg 639, 2007, Demarzo, Corporate
Finance
6 Although not requested, for comparative purposes the RWACC has also been calculated. The results can be
found in Q1.ACC.SBS.xls

Bilal Al- Qureshi, Said Business School, University of Oxford 2010

The unlevered, debt free, cost of capital is cheaper than the levered cost of capital
2. Project Cash Flow without Laminate Technology
Reference: Q2.ACC.SBS.xls
a) Project the incremental cash flows associated with the acquisition of Collinsville
Although the attributes relating to the period 1980 till 1984 were readily available from exhibit
8, our model was developed to be fully computational.
Thus, we first computed the operating income, (EBIT) by subtracting7 the cost of goods sold
and depreciation from the revenue.
We then calculated the Earnings before interest and after tax with specification 7:
(7) EBIAT = EBIT * (1 T)
The second phase of our calculation determined the capital expenditure.
Capital Expenditures include expenditures on new and replacement property, plant and
equipment. Thus, we calculated Capital expenditures by measuring the increase in net
property, plant and equipment plus depreciation. (Source: Pg174 Copeland et al, 1996)
The third phase of our calculation determined the change in working capital between two time
periods. In order to do so, we first calculated the working capital. This was achieved by the
summation of Accounts receivables, inventories less accounts payable.
In light of the aforementioned, specification 8 was used to determine incremental cash flows.
(8) FCF = EBIAT + DEP - CAPEX - CH in W/ CAP
The cited schema was also applied for the period 1985-1989 however, the following line items
had to be forecasted, based on the assumptions cited in table 1.
Forecasted Items
Depreciation, Operating Profit, Capex, Accounts receivables, inventories less accounts
payable.
Table 3 presents our Incremental Cash Flow (C.F) results.
Table 3
Year
FCF
($000)
7

1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
$12,000 $1,206 $1,407 $1,891 $2,074 $2,073 $2,214 $2,497 $2,594 $2,890 $3,021

Manufacturing Cost and the Other charges as labeled in exhibit 8

5
Bilal Al- Qureshi, Said Business School, University of Oxford 2010

b) Value of the Collinsville Plant, without laminate technology

As per table 4, using the WACC approach, we discount the FCF to Present Value.
Table 4
Year

1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
FCF($000) $12,000 $1,206 $1,407 $1,891 $2,074 $2,073 $2,214 $2,497 $2,594 $2,890 $3,021
Discount
Rate
1.00
0.88
0.77
0.67
0.59
0.52
0.45
0.40
0.35
0.30
0.27
Discount
(C.F)
$12,000 $1,061 $1,083 $1,267 $1,224 $1,078 $996
$999
$908
$896
$816
PV
$10,299
The present value of the Collinsville plant, without laminate technology is $10,299,000
3. Project the Incremental Cash Flows associated with the investment in Laminate
Technology
Reference: Q3.ACC.SBS.xls
We consider the cash flows yielded by the installation of laminate technology independent to
the cash flows of Collinsville plant.
Installation of laminate technology can result in the elimination of graphite costs, and a
reduction in power consumption by 17.58%. Thus, we sum the cited to compute cost savings,
and depreciate the investment over 10 years.
Table 5 depicts the incremental cash flows associated with this investment.
Table 5
Year
FCF
Discount
Rate
Discounted
CF

1980
1981
-$2,140 $1,209

1982
$1,402

1983
$1,538

1984
$1,677

1985
$1,830

1986
$1,999

1987
$2,187

1988
$2,394

1989
$2,625

0.88

0.77

0.67

0.59

0.52

0.45

0.40

0.35

0.30

0.27

-$1,883

$931

$939

$907

$872

$824

$800

$765

$718
PV

$709
$7,465

The present value of the incremental cash flows associated with an investment in Laminate
Technology is $7,465,000.

Actual power reduction is between 15%-20% however, we will take the mean
6

Bilal Al- Qureshi, Said Business School, University of Oxford 2010

4. What is the NPV of the acquisition with Laminate Technology

Reference: Q4.ACC.SBS.xls
We amalgamate the EBIT and depreciation of Collinsville and Laminate Technology,
respectively. We also factor in the investment needed to install the Laminate Technology in to
our capital expenditure.
The NPV of the total acquisition is $3,880,000
4.b What is the NPV of the acquisition with Laminate Technology, with a 25%
probability that the technology fails after the plant has been purchased
Reference: Q4b.ACC.SBS.xls
We develop a FCF absent of any potential benefits from the installation of Laminate
Technology nonetheless; we maintain the following assumptions:

The investment value of $2250m is factored in to the capital expenditure

Depreciation of Laminate Technology over 10 years

Thus the NPV of Collinsville plant, including the expectation of Laminate Technology
failing, in conjunction with the aforementioned assumptions is $- 2,904,000, at a 100%
failure rate.
The NPV of the laminate technology project is $5,582,000, at a 100% success rate.
We use specification 9 to calculate the expected return
(9)Expect Return = NPV * Success (75%)+ NPV Failure (25%)
Thus we use the weights identified in table 6 to adjust our NPVs.
Table 6
L.T
Probability Savings NPV
Fail
25%
0
-$2,904
Success
75%
100%
5582
$3,461
By summing the weighted NPVs, we now have a revised NPV of $3,461,000
5 Is this acquisition a good investment for the proposed price?
Inline with the NPV doctrine, we recommend that Dixon should abstain from acquiring the
Collinsville plant, as a negative NPV of $1701 million equates to concurrently reducing
shareholder value. Nonetheless, it is recommended that Dixon should acquire the Collinsville
plant, in conjunction with Laminate Technology. This recommendation is supported by the
results computed in Q4.B, despite a 25% probability of technology related failure, a positive
NPV is deducible.

Bilal Al- Qureshi, Said Business School, University of Oxford 2010

The offer price could, perhaps factor the R&D costs attributed to American Chemical
Corporation thus; the proposed price was inflated to accordingly reap back monies spent.
As per Page 4 of the case, the acquisition of Collinsville plant would complement Dixons
strategy of supplying chemicals to the paper and pulp industry. According to page 2 of the
case, one requires approximately $16m to finance a newly built 40,000 ton sodium chlorate
plant ergo, relative to building a new plant; it is recommended that Dixon acquire the
Collinsville with Laminate technology as the acquisition is less capital intensive, does not
entertain a construction building lag and impedes on the competition.
5.b Have you any alternative suggestions, Recommendations
It is quite clear that Laminate technology contributes to the economic efficiency of the
acquisition of Collinsville, construction, development and installation delays will affect the
NPV therefore, Dixon should contractually hedge itself against the aforementioned.
As power consumption accounts for 55% - 60% of manufacturing cost, Dixon should
investigate the possibility of structuring Forward Power purchasing contracts with the
Tennessee Valley Authority.

Bilal Al- Qureshi, Said Business School, University of Oxford 2010

Bibliography
Websites:
Equity Risk Premium
http://www.investopedia.com/articles/04/012104.asp
Interpretation of Flat EBIT
http://www.imf.org/external/pubs/ft/wp/2006/wp06218.pdf
Books:
Copeland et al, 1996, Valuation, Measuring and Managing the Value of Companies,2nd Edition,
Mckinsey & Company, Inc.
2007, Demarzo, P et al Corporate Finance, Pearson International

Bilal Al- Qureshi, Said Business School, University of Oxford 2010