Dixon Case Study

1.What are good comparable companies for the Collinsville plant? List the companies and why you think they are good comparables.  

We think Brunswick and Southern, which specialized in producing sodium chlorate, should be the proper comparable companies for the Collinsville plant. According to the case, Collinsville focused on producing sodium chlorate. Discount rates are firm-specific, we should find some “pure-play’ companies to compare with. Brunswick and Southern are the only two “pure-play” companies while other big companies, such as Hooker, Pennwalt, are all diversified chemical companies. Therefore, comparing Collinsville project with those diversified companies is not appropriate.

2. What is the D/(D+E) in market value that Dixon has planned for the combined entity (i.e., Dixon + Collinsville)? Is it reasonable to assume this is the target capital structure for the Collinsville plant?

We use the data from 1979, in which Dixon decided to launch the project. And we assume that the market value of debt is the same as the book value. For equity, we use the profits after taxes and EPS to calculate the number of shares, and use the closing stock price as the market stock price. By multiplying the number of shares and stock price, we get the equity value: 43978.14. The Dixon’s original debt at 1979 is 1000 (we exclude the current liability which was caused from daily operating from debt). Then Dixon purchased the Collinsville plant at $12 million, using $4 million of its own cash,  which would not change its capital structure, and issuing $8 million bond with two insurance companies, which added $8 million debt. Therefore, the combined entity’s D/(D+E) in market value is 16.99%.

It is not reasonable to assume that the Dixon’s own capital structure is the target capital structure for the Collinsville plant, because Dixon and Collinsville are not in the same line of business. We should find “pure play” companies with the same line of business as Collinsville plant and use their capital structure as the project’s D/(D+E).

3.Estimate the weighted average cost of capital (WACC) that is appropriate for discounting the Collinsville plant’s incremental cash flows. You should estimate and present each component of the WACC separately, explaining clearly what assumptions you are making for each of them.

Assumption:

1.Brunswick Chemicals and Southern Chemicals are two “pure play” companies, and they also produce sodium chlorate. For the capital structure, we can use the average of their capital structure. According to the chart below, we assume D/(D+E）=10%

[pic 1]

2. We assume the issued bond is Collinsville’s only debt, and the bond’s market value is approximately the same as par value. Therefore we can use the 11.25% interest rate as the return of debt.

3.We assume the bond is safe, so beta D=0.

4. In the note of this case, we got the information that long-term treasury bond’s interest rate is 9.5%, and we use it as the risk-free rate.

5. According to historical data online, the risk-premium in 1979 was 8.4%.

6. We calculate the asset beta for the six companies in Exhibit 5. We find that the first three companies’ asset betas are very low, maybe because they have diversified business operations. The two “pure play” companies’ asset betas are higher, maybe the sodium chlorate project can increase beta. So we should ignore the other four companies and focus on the two “pure play” companies. Since the asset betas of the two companies are close, we use the average as the plant’s asset beta. And we relever it to get equity beta.