Investment Case Study
Do the circumstances surrounding the sale of the Collinsville plant play any role in your willingness to buy the assets? If so, how, if not, why not?
On the one hand, the circumstances of the sale make me less willing to buy. In particular, both Universal and the federal government think that American’s acquisition creates antitrust issues. If this is the case, American could use its market power to change the nature of the market and make Dixon’s new plant unprofitable by setting lower prices for sodium chlorate in its other plants. On the other hand, the circumstances make me more willing to buy the assets because American has to divest the plant to comply with a court order. Therefore, they have less leverage during the sale because there are only a limited number of purchasers and American must sell. I would be more willing to purchase the plant given that demand for sodium chlorate is expected to continue increasing. On the other hand, power costs which account for the majority of manufacturing costs were rising making it more expensive to produce.
1) Which firms are relevant for obtaining an asset beta for the Collinsville investment? Using the betas, determine the appropriate discount rate for the investment. Evaluate the investment.
We are interested in obtaining the asset beta for the Collinsville investment. We can estimate asset betas by 1) looking it up in Bloomberg, 2) finding “identical twins” and comparing their betas, and 3) un-levering the beta from the company itself. Here, using 2 and 3 we are interested in both the asset beta of Dixon as well as the asset betas of companies whose assets are similar to the project (e.g. companies that own plants that produce Sodium Chlorate). Here, assuming a low grade debt beta of .3, Dixon has an unlevered beta of .73 based on the average debt/equity ratio from 1975-1979.[1] However, it is important to note that Dixon has reduced debt in recent years so the unlevered beta goes up to .81
On the one hand, the circumstances of the sale make me less willing to buy. In particular, both Universal and the federal government think that American’s acquisition creates antitrust issues. If this is the case, American could use its market power to change the nature of the market and make Dixon’s new plant unprofitable by setting lower prices for sodium chlorate in its other plants. On the other hand, the circumstances make me more willing to buy the assets because American has to divest the plant to comply with a court order. Therefore, they have less leverage during the sale because there are only a limited number of purchasers and American must sell. I would be more willing to purchase the plant given that demand for sodium chlorate is expected to continue increasing. On the other hand, power costs which account for the majority of manufacturing costs were rising making it more expensive to produce.
1) Which firms are relevant for obtaining an asset beta for the Collinsville investment? Using the betas, determine the appropriate discount rate for the investment. Evaluate the investment.
We are interested in obtaining the asset beta for the Collinsville investment. We can estimate asset betas by 1) looking it up in Bloomberg, 2) finding “identical twins” and comparing their betas, and 3) un-levering the beta from the company itself. Here, using 2 and 3 we are interested in both the asset beta of Dixon as well as the asset betas of companies whose assets are similar to the project (e.g. companies that own plants that produce Sodium Chlorate). Here, assuming a low grade debt beta of .3, Dixon has an unlevered beta of .73 based on the average debt/equity ratio from 1975-1979.[1] However, it is important to note that Dixon has reduced debt in recent years so the unlevered beta goes up to .81