Dixon Case
Bus M 401
Dixon Case
Estimate of WACC for Collinsville Plant
The WACC for Collinsville, according to our estimations, came up to about 16.22% (Exhibit I). We took the average of the unlevered betas of comparable companies, 0.91, and relevered it according to Dixon’s target capital structure. Dixon’s 5-year historical debt ratio was 27.5%, but this approach would not be reliable due to its steep downturn debt ratio from 51% in 1975 to 6% in 1979. Thus, we thought that the best estimate of the target debt ratio is 15% for calculation of the WACC.
The risk-free rate used was the long-term Treasury bond rate of 9.5% while the debt rate premium was calculated by subtracting the long-term Treasury bond rate from the long-term “AA” corporate bond rate. With Dixon’s ability to cover interest expense and relatively low target debt ratio, we applied “AA” rating to Dixon, which yielded the debt premium of 0.75%.
Incremental Cash Flows Associated with Acquisition – Without Laminate Technology
We developed pro forma financial statements with projected incremental cash flows associated with this acquisition (Exhibit II). Following 1984, the following assumptions are used: (1) EBIT stabilizes and stays constant at 1984 levels through 1989, (2) capital expenditures are 600 per year after 1984, (3) net working capital increases by 8% per year after 1984. The 8% increases in Net Working Capital were assumed to be driven by an increase of difference between current asset and current liability by subtracting accounts payable from inventory and accounts receivable.
From what we calculated in 1979, the first figure is the initial outlay of $12 million from $ 10.6 million for the purchase price and $1.4 million for the initial net working capital initiating Collinsville plant. Following that, we calculated the free cash flow for each year. We calculated the free cash flow by applying tax effects to EBIT (times EBIT by 1 minus the tax rate of 45.05%), adding back depreciation
Dixon Case
Estimate of WACC for Collinsville Plant
The WACC for Collinsville, according to our estimations, came up to about 16.22% (Exhibit I). We took the average of the unlevered betas of comparable companies, 0.91, and relevered it according to Dixon’s target capital structure. Dixon’s 5-year historical debt ratio was 27.5%, but this approach would not be reliable due to its steep downturn debt ratio from 51% in 1975 to 6% in 1979. Thus, we thought that the best estimate of the target debt ratio is 15% for calculation of the WACC.
The risk-free rate used was the long-term Treasury bond rate of 9.5% while the debt rate premium was calculated by subtracting the long-term Treasury bond rate from the long-term “AA” corporate bond rate. With Dixon’s ability to cover interest expense and relatively low target debt ratio, we applied “AA” rating to Dixon, which yielded the debt premium of 0.75%.
Incremental Cash Flows Associated with Acquisition – Without Laminate Technology
We developed pro forma financial statements with projected incremental cash flows associated with this acquisition (Exhibit II). Following 1984, the following assumptions are used: (1) EBIT stabilizes and stays constant at 1984 levels through 1989, (2) capital expenditures are 600 per year after 1984, (3) net working capital increases by 8% per year after 1984. The 8% increases in Net Working Capital were assumed to be driven by an increase of difference between current asset and current liability by subtracting accounts payable from inventory and accounts receivable.
From what we calculated in 1979, the first figure is the initial outlay of $12 million from $ 10.6 million for the purchase price and $1.4 million for the initial net working capital initiating Collinsville plant. Following that, we calculated the free cash flow for each year. We calculated the free cash flow by applying tax effects to EBIT (times EBIT by 1 minus the tax rate of 45.05%), adding back depreciation