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Risk and Assets

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Submitted By marciano
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1. I assume the Georgia-Pacific, Brunswick Chemical and Southern Chemicals are the identical twins of the Collinsville investment because their net incomes during the 1974 to 1978 period have extremely high correlation with Collinsville’s net income. Net Income (in millions) | Collinsville | Brunswick Chemical | Georgia-Pacific | Southern Chemicals | 1974 | 1.096 | 0.2 | 164 | 0.1 | 1975 | 0.817 | 0.15 | 148 | -0.05 | 1976 | 2.326 | 0.37 | 215 | 0.28 | 1977 | 4.357 | 0.71 | 262 | 0.74 | 1978 | 4.845 | 0.79 | 302 | 0.73 | Coefficient of Determination | / | 99.9% | 97.6% | 98.1% |

| Equity Beta | Debt | Equity | Asset Beta | Brunswick Chemical | 1.1 | 15% | 85% | 0.935 | Georgia-Pacific | 1.5 | 29% | 71% | 1.065 | Southern Chemicals | 1.2 | 21% | 79% | 0.948 | Average Asset Beta | | | | 0.9415 |
Eliminate Georgia Pacific from the identical twins list Collinsville’s asset beta is 0.9415.
& Risk-free rate = long-term treasury bonds = 9.5%; Market risk premium = 7% Discount rate of Collinsville = 9.5% + 0.9415 * 7% = 16.09% (CAPM)

2. | 1980 | 1981 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | 1988 | 1989 | Sales (tons) | 32,000 | 35,000 | 38,000 | 38,000 | 38,000 | | | | | | Ave price/ton | 415 | 480 | 520 | 562 | 606 | | | | | | Sales | 13,280 | 16,800 | 19,760 | 21,356 | 23,028 | | | | | | Power | 6,304 | 7,735 | 9,386 | 10,526 | 11,780 | | | | | | Graphite | 645 | 791 | 875 | 940 | 992 | | | | | | Salt and other | 1,285 | 1,621 | 1,753 | 1,836 | 1,956 | | | | | | Labor | 1,180 | 1,297 | 1,427 | 1,580 | 1,738 | | | | | | Maintenance | 256 | 277 | 299 | 322 | 354 | | | | | | Other | 1,154 | 1,148 | 1,179 | 1,113 | 1,153 | | | | | | Total costs | 10,824 | 12,869 | 14,919 | 16,317 | 17,973 | | | | | | Depreciation | 1,060 | 1,110 | 1,160 | 1,210 | 1,270 | 1,330 | 1,390 | 1,450 | 1,510 | 1,570 | Selling | 112 | 125 | 138 | 152 | 168 | | | | | | R&D | 451 | 478 | 508 | 543 | 591 | | | | | | Operating Profit | 833 | 2,218 | 3,035 | 3,134 | 3,026 | 3,026 | 3,026 | 3,026 | 3,026 | 3,026 | A/R | 1,328 | 1,680 | 1,976 | 2,136 | 2,303 | | | | | | Inventories | 598 | 756 | 889 | 961 | 1,036 | | | | | | Account payable | 730 | 924 | 1,087 | 1,175 | 1,267 | | | | | | Change in WC | -204 | 316 | 266 | 144 | 150 | 0 | 0 | 0 | 0 | 0 | Net PP&E | 10,025 | 9,440 | 8,840 | 8,230 | 7,560 | 6,830 | 6,040 | 5,190 | 4,280 | 3,310 | Capital-Ex | 485 | 525 | 560 | 600 | 600 | 600 | 600 | 600 | 600 | 600 | Tax expense | 400 | 1,065 | 1,457 | 1,504 | 1,452 | 1,452 | 1,452 | 1,452 | 1,452 | 1,452 | FCF | 1,212 | 1,422 | 1,912 | 2,096 | 2,094 | 2,304 | 2,364 | 2,424 | 2,484 | 2,544 |
NPV = $9.2 million (discounting at a 16.09% discount rate)
After subtracting $12 million initial payments for the plant, Net NPV = $ -2.9 million

3. | 1980 | 1981 | 1982 | 1983 | 1984 | 1985 | 1986 | 1987 | 1988 | 1989 | Previous profit | 833 | 2,218 | 3,035 | 3,134 | 3,026 | 3,026 | 3,026 | 3,026 | 3,026 | 3,026 | CS on graphite | 0 | 791 | 875 | 940 | 992 | 1,042 | 1,094 | 1,148 | 1,206 | 1,266 | CS on power | 0 | 1,354 | 1,643 | 1,842 | 2,062 | 2,309 | 2,586 | 2,896 | 3,244 | 3,633 | Add’l Cap-Ex | 2,250 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | Total Cap-Ex | 2,735 | 525 | 560 | 600 | 600 | 600 | 600 | 600 | 600 | 600 | Add’l depr. | 0 | 225 | 225 | 225 | 225 | 225 | 225 | 225 | 225 | 225 | Total depr. | 1,060 | 1,335 | 1,385 | 1,435 | 1,495 | 1,555 | 1,615 | 1,675 | 1,735 | 1,795 | New profit | 833 | 4,138 | 5,328 | 5,691 | 5,855 | 6,151 | 6,481 | 6,846 | 7,251 | 7,700 | New tax expense | 400 | 1,986 | 2,557 | 2,732 | 2,810 | 2,953 | 3,111 | 3,286 | 3,480 | 3,696 | New FCF | -1,038 | 2,646 | 3,329 | 3,650 | 3,789 | 4,154 | 4,385 | 4,635 | 4,905 | 5,199 |
NPV = $14.1 million (discounting at a 16.09% discount rate, assuming laminate can reduce power usage by 17.5%)
After subtracting $12 million initial payments for the plant, Net NPV = $ 2.1 million
4.
Based on previous calculation, the incremental NPV of Collinsville plant ($14.1 MM) is greater than the amount that Dixon agreed to pay. Therefore, I think Dixon should purchase the Collinsville plant.

However, I am very cautious about the profit projection I got after adding the laminate technology to the Collinsville plant. Because of the laminate technology, the Collinsville will be able to achieve huge amount of cost saving on power expense, which will effectively increase its net profit and free cash flow in the future. In fact, this technology essentially increases the NPV of this project by over 50%.

As one can see, the performance of this project essentially depends on the laminate technology’s cost saving effectiveness. According to my calculation, if the laminate technology can save around 12% of the power expense, this project will breakeven. Therefore, if investors in Dixon believe that the laminate technology can at least save 12% of the power expense, they should invest in this project.

--------------------------------------------
[ 1 ]. CS = Cost Saving

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