Dixon Corporation Case Analysis
1) Estimate the 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 briefly but clearly what assumptions you are making for each of them. In the same spirit, estimate the appropriate all-equity cost of capital for the APV-based valuation.
WACC calculation.
WACC = RD*(1-t)*D/(D+E)+RE* E/(D+E)
Cost of equity
We assume that risk free rate (Rf) equals rate of long-term Treasury Bonds (as the project’s life is 10 years), so Rf = 9.5%.
According to Aswath Damodaran equity risk premium in the US in 1979 was 6.45%, thus
Rm – Rf = 6.45%.
We will estimate beta equity using data of comparable firms, focusing on production only sodium chlorate: Brunswick Chemical and Sothern Chemicals. To calculate beta asset we’ll use information about beta equity and equity-to-value ratio. As well we assume that debt beta equals zero:
To adjust beta in accordance with project we assume that in the long-run Dixon will maintain its target debt-to-capital ratio in proportion of 35%. Thus, we get the following beta asset of the project that accounts for Dixon’s capital structure:
Betaproject = 0.94/(1-0.35) = 1.45
RE = Rf + Bproject*(Rm-Rf) = 9.5% + 1.45*6.45% = 18.85%
Cost of debt
We assume that cost of debt equals 11.25% as Dixon issue bonds at this rate for the purpose of this project financing.
Marginal tax rate = 3,818/(3,818+4,024) = 48,68%
RD*(1-t) = 11.25%*(1-48.68%) = 5.77%
WACC
WACC = RD*(1-t)*D/(D+E)+RE* E/(D+E) = 5.77%*0.35 + 18.85%*0.65 = 14.27%.
APV-based evaluation
The rate we’re looking for APV evaluation is return on equity if this project is 100% equity financed. So we use unlevered average beta for evaluation as equity-to value ratio equals 1.
Betaequity = Betaasset = 0.94
RE = Rf + Bequity*(Rm-Rf) = 9.5% + 0.94*6.45% = 15.56%
2) Project the incremental cash flows associated with the acquisition of the Collinsville
WACC calculation.
WACC = RD*(1-t)*D/(D+E)+RE* E/(D+E)
Cost of equity
We assume that risk free rate (Rf) equals rate of long-term Treasury Bonds (as the project’s life is 10 years), so Rf = 9.5%.
According to Aswath Damodaran equity risk premium in the US in 1979 was 6.45%, thus
Rm – Rf = 6.45%.
We will estimate beta equity using data of comparable firms, focusing on production only sodium chlorate: Brunswick Chemical and Sothern Chemicals. To calculate beta asset we’ll use information about beta equity and equity-to-value ratio. As well we assume that debt beta equals zero:
To adjust beta in accordance with project we assume that in the long-run Dixon will maintain its target debt-to-capital ratio in proportion of 35%. Thus, we get the following beta asset of the project that accounts for Dixon’s capital structure:
Betaproject = 0.94/(1-0.35) = 1.45
RE = Rf + Bproject*(Rm-Rf) = 9.5% + 1.45*6.45% = 18.85%
Cost of debt
We assume that cost of debt equals 11.25% as Dixon issue bonds at this rate for the purpose of this project financing.
Marginal tax rate = 3,818/(3,818+4,024) = 48,68%
RD*(1-t) = 11.25%*(1-48.68%) = 5.77%
WACC
WACC = RD*(1-t)*D/(D+E)+RE* E/(D+E) = 5.77%*0.35 + 18.85%*0.65 = 14.27%.
APV-based evaluation
The rate we’re looking for APV evaluation is return on equity if this project is 100% equity financed. So we use unlevered average beta for evaluation as equity-to value ratio equals 1.
Betaequity = Betaasset = 0.94
RE = Rf + Bequity*(Rm-Rf) = 9.5% + 0.94*6.45% = 15.56%
2) Project the incremental cash flows associated with the acquisition of the Collinsville