American Chemicals

To: CEO of Dixon Corporation

From: Yutong LI

Subject: Recommendation on the Acquisition of Collinsville plant

Dixon Corporation recently has been considering about acquiring Collinsville plant, the sodium chlorate production unit of American Chemical Corporation. From strategic and economic point of view, it is recommended that Dixon should approve the acquisition under the condition that the laminating technology is acquired at the same time.

From economic point of view, free cash flow analysis is conducted to find the net present values of this project under two scenarios are -$2,082 and $3,148 accordingly. We can back out PV of laminating technology is $5,230.

Amount in ,000 USD | Without laminating technology | With laminating technology | Laminating technology |

Initial investment | -$12,000 | -$14,250 | |

PV (future cash flow) | $9,918 | $17,398 | |

NPV | -$2,082 | $3,148 | $5,230 |

To calculate these numbers, projections about the profitability of Collinsville plant given in Exhibit 8 is used and further projection until 1989 was also made to match the 10 year length of life of the plant. The further projection is based on a set of assumptions which is included in the appendix.

To find a proper discounting rate, WACC, Dixon`s target capital structure of 35% debt is used. Dixon`s income statement of 1979 is used to calculate the tax rate which is 48.69%. Interest rate of 11.25% is used as proxy for cost of debt. CAPM is used to calculate cost of equity, with risk free rate of 9.5% and equity risk premium of 6%. For beta calculation, all the sodium chlorate producers given by Exhibit 5 are used to calculate the asset beta. After unlevering, we get average asset beta of 0.85. Then we relever beta using capital structure of 65% equity and find levered beta for the plant to be 1.31. WACC is calculated to be 13.3%.

From net present values we get from FCF analysis, it seems that the plant without laminating technology is not attractive...