American Chemical Corporation Liquidation and Investment Analysis Assignment Questions

Question 1: Value the Collinsville plant as it stands with the unlaminated graphite electrodes.

Using the following information to make your valuation:
a. Extend management’s projections contained in Exhibit 8 through 1990 under the following assumptions (project only the additional items you need for the FCF calculation):
i. The plant reaches effective capacity of 38,000 tons in 1982. Revenue increases thereafter reflect only unit price increases of 8% annually.
ii. Power costs rise at 12% per annum after 1984.
iii. Annual capital expenditures will be $500,000 in 1980, 1981, and 1982. From 1983 through to 1989 annual capital expenditure will be $600,000. No additional CAPEX will occur in 1990 as the plant closing approaches. See the note below on PP&E for further information.
iv. All capital expenditures are depreciated straight-line over 10 years. (I have corrected Exhibit 8 in the spreadsheet to reflect this. Use these corrected numbers). Depreciation of any capital equipment starts the year after it is purchased.
v. The tax rate is 48% throughout.
vi. With the above exceptions and the items they affect, after 1984 other items should be forecast to grow at the same rate as sales. In other words, these other items are expected to maintain the same ratio to sales from 1984 onwards.
b. Estimate free cash flows for each year 1980-1989.
c. Estimate the free cash flows in 1990. This will include the free cash flow from operating the plant in 1990 and the cash flow consequences of shutting down the plant at the end of the year. Assume account receivables will be liquidated at 100% of its 1990 book value, inventory at 80% of its 1990 book value2 and PP&E at 0%. Treat the tax consequences of book losses of the liquidation of all these assets in the same way we treat book losses of PP&E so that any book losses (i.e. the difference between liquidation value and book value) can be used to lower taxable income. Assume that Dixon will have enough taxable income and capital gains from its other operations so that the tax benefits of the book losses on all assets can be used right away in 1990 at the 48% tax rate. Assume that accounts payable will be paid in full in 1990.
d. Estimate Dixon’s opportunity cost of capital for acquiring the Collinsville plant? Assume management’s target debt ratio (i.e. ND/(ND+E)) for the Collinsville plant is 15%. Use this ratio for your WACC calculation. Disregard the information on the second last paragraph about the proposed financing of the deal. For the cost of debt use 11.25% (we will discuss this number in class). Information on potential comparable firms is provided in Exhibits 1, 2 and 5. You should choose which firms to use and justify your choice.