American Chemical Corporation - Paper

Topics: Weighted average cost of capital, Corporate finance, Cash flow Pages: 2 (529 words) Published: April 12, 2012
Executive Summary

Statement of the problem
In October of 1979, the American Chemical Corporation (ACC) began looking for a buyer for the Collinsville, Alabama plant after successfully acquiring 91% of the shares of Universal Paper Corporation. Dixon Corporation, a specialist chemical company with customers primarily in the paper and pulp industry agreed to the possibility of purchasing the Collinsville plant for $12 million. This purchase will diversify Dixon’s product line, adding the sodium chlorate chemical, produced at the Collinsville plant, needed by its existing customers. Dixon is evaluating different streams of cash flows for the possibility of purchasing the Collinsville plant.

The decision to acquire Collinsville’s plant will translate into strategic and economic benefits. Dixon could increase their supply of chemical products to their existing clients. However, first we looked in to the risk of the possible venture. Dixon has never produced sodium chlorate which could add risk to the new venture. For this reason we calculated the beta of the project based on the beta of the sodium chlorate industry. We focused on Brunswick and Southern Chemical which are pure play sodium chlorate companies. The average unleveraged beta obtained from the two companies is 1.035 which reflects the risk of the project. Adjusting Dixon’s beta by re-levering it using its own target capital structure of 35% ends with a beta of 1.59. The beta obtained is used to derive the CAPM method, resulting in a 21.45% cost of equity. We assumed that the debt borrowed by Dixon has a rate of 11.25% calculating an after-tax cost of debts of 5.85%. Therefore, the weighted average cost of capital (WACC) for Collinsville’s plant cash flow is nearly 16%. This ratio will be used to evaluate the different NPV’s of the projects.

To make an investment decision three scenarios have been analyzed. The first and second scenarios are to finance the plant in 5 years or 10...
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