1.

Estimate the cost of equity appropriate for the evaluation of the incremental cash flows associated
with the Collinsville investment. Estimate the weighted average cost of capital appropriate for
discounting the Collinsville plants incremental cash flows.
To calculate the weighted average cost of capital, we used the assumptions / data below and derived a
cost of equity and cost of debt to be 16.6% and 11.0%, respectively. Pre-acquisition WACC was 16.3%;
however, with the addition of debt issued at a lower cost as compared to equity, and following
Modigliani and Millers theorem, the post-acquisition WACC decreased to 14.1% given the addition of
tax-deductible interest expense, which reduces overall taxes, increases firm value, and decreased the
firms WACC.
Dixon Corp
Risk Free Rate (Short term T-Bills)
Market Risk Premium
Implied Effective Tax Rate
Brunswick & Southern Avg. Asset Beta
Dixon Target Capital Structure (D/E)
Dixon Levered Equity Beta
Dixon Cost of Equity

9.5%
5.5%
48.0%
1.01
0.35
1.29
16.6%

footnote 2
Acceptible return for project (15%) minus risk-free rate
computed in Exhibit 7
computed in Exhibit 5
per case on page 4
computed

Dixon Equity
Closing Price on 10/31/1979
EPS 1979
Net Income 1979
Shares Outstanding

43,978
40
3.66
4,024
1,099

computed
Exhibit 7
Exhibit 7
Exhibit 7
computed

Dixon Debt (Current 1979)

Current Debt Interest (Implied)
Dixon Debt (Newly Issued for Acquisition)
New Debt Interest
Weighted Average Interest (Cost of Debt)

1,000
8.0%
12,000
11.3%
11.0%

per Exhibit 7
computed
per case on page 4
per case on page 4
computed

Post Acquisition Debt-to-Capital (Market)

22.8%

computed

Pre Acquisition WACC

Post Acquisition WACC

16.3%
14.1%

computed
computed

LT Growth Rate (Low)

LT Growth Rate (High)
CapEx (Low)
CapEx (High)

1.0%
3.0%
475
600

assumption
assumption
per case on page 3
per case on page 3

* Used companies in same industries to determine Asset Betas

2. Project the incremental cash flows associated with the acquisition of the Collinsville plant without
the laminate technology and estimate the acquisitions net present value.
As stated in the case, the exhibit 7 pro-formas are estimated without the laminate. Our team performed
a FCFF and NPV analysis on these assumptions, using a conservative CAPEX estimate from the case
($600k/yr) and a LT growth rate assumption of 1%. We also assumed a price increase of 0.48% in 1981

and 1982 (which was the forecasted price increase from 1979 to 1980). We made this assumption
based on new capacity that was expected to be placed in service in the Southeast U.S.
Pro Forma Financial Statements for the Collinsville Plant Without Laminate (000s)
Expected
12/31 1979
EBIT
NOPAT
After-tax Interest
Depreciation
CA
CL
NWC
Change in NWC
CapEx
FCFF
PV FCFF
PV of Terminal Value
Sum of PV of FCFs
Purchase Price
NPV

$2,273
873
$1,400

1980
$833
$433
$702
$1,060
$1,926
730
$1,196
$204
$600
$1,799
$1,576

For the Years Ended December 31,

1981
1982
1983
$13
($802)
($1,025)
$7
($417)
($533)
$702
$702
$702
$1,110
$1,160
$1,210
$2,436
$2,865
$3,097
924
1087
1175
$1,512
$1,778
$1,922
($316)
($266)
($144)
$600
$600
$600
$903
$579
$635
$693
$390
$374

1984
($1,429)
($743)
$702
$1,270
$3,339
1267
$2,072
($150)
$600
$479
$247

Terminal

$3,684

$6,965
($12,000)
($5,035)

Project the incremental cash flows associated with the 1980 investment in laminate technology and
estimate the investments net present value.
Similar to the above, we maintained the same CAPEX, LT growth rates and pricing assumptions.
Furthermore, we eliminated graphite costs starting in 1981 using a conservative cost saving measure for
power (15%) and used SL depreciation for the Laminate project ($225k/yr) for the $2.25 million CAPEX
project slated for 1980.
Pro Forma Financial Statements for the Collinsville Plant With Laminate (000s)
Expected
12/31 1979
EBIT
NOPAT
After-tax Interest
Depreciation
CA
CL
NWC
Change in NWC
CapEx
FCFF
PV FCFF
PV of Terminal Value
Sum of PV of FCFs
Purchase Price
NPV

$2,273
873
$1,400

1980
$833
$433
$702
$1,060
$1,926
730
$1,196
$204
$2,850
($451)
($395)

For the Years Ended December 31,

1981
1982
1983
$1,740
$1,256
$1,269
$905
$653
$660
$702
$702
$702
$1,335
$1,385
$1,435
$2,436
$2,865
$3,097
924
1087
1175
$1,512
$1,778
$1,922
($316)
($266)
($144)
$600
$600
$600
$2,026
$1,874
$2,053
$1,555
$1,261
$1,210

1984
$1,105
$574
$702
$1,495
$3,339
1267
$2,072
($150)
$600
$2,021
$1,044

Terminal

$15,554

$20,229
($12,000)
$8,229

3. Is the Collinsville proposal attractive on economic grounds?

Yes, on economic grounds the investment provides a positive NPV with the laminate technology.
Our teams assessment skews conservative. The conservative levers that we project are the following:
2|Page

Implied effective tax rate (high)

Long-term growth (low)
Price increases (modest)
Power cost reduction (low)
CAPEX expenditure (high)

NPV w/o Laminate

NPV w/Laminate
+401
+3,883
-748
-3,160
+600 to 900 per pp (see sensitivity analysis)
n/a
-2,995
+1,292
+1,390

Even with all of these levers skewing conservative, the investment proves a positive NPV with Laminate
technology.

4. Assess the strategic issues associated with the proposal. Is Collinsville attractive on strategic
grounds?
Yes, Collinsville is an attractive strategic acquisition for Dixon. The plant would allow Dixon to realize
economies of scope from its sales and marketing personnel and distribution network. It would also
position Dixon immediately as one of the top four regional suppliers, in terms of capacity, of sodium
chlorate. Dixon also already produces one of the necessary inputs required to convert sodium chlorate
into chloride dioxide, sulfuric acid. Finally, the acquisition could preempt other emerging competitors
from gaining a foothold with paper and pulp customers on other chemicals.

5. As CEO of Dixon Corporation, would you approve the acquisition of the Collinsville plant at the price
and on the terms proposed? Why, or why not? What alternatives, if any, would you suggest?
No, we would not approve the acquisition at the price or on the terms proposed. Although the
acquisition is attractive under the scenarios described in the case, recent market developments
introduce too much uncertainty around projections to approve the deal as proposed. New competitor
plant construction means the imminent addition of 75,000 tons of capacity, or 24% of existing regional
output.
The Dixon CEO should hedge against the risk that the market prices will not increase at an average
annual rate of 8% after 1980. Under a conservative forecast of price behavior, we show that if price
increases remain constant at 0.048% (the price rate of change between 1979 and 1980^) until 1982, and
prices increase by 8% in 1983 and 1984, the NPV of the project without laminate installed is -$5.035
million.
We performed a real option valuation of the opportunity to install the laminate technology in 1980,
assumed the investment would be funded by issuance of new debt, and the plant would therefore
realize the efficiencies described in the case for subsequent years. The NPV of the option is $4.996
million, as shown in Exhibit 7. The NPV of the acquisition and the laminate investment option is -$40K.
We therefore propose that the Dixon CEO approve the acquisition only if American includes the cost of
the laminate install in the acquisition package.

3|Page

Appendix 1 NPV Scenario Analysis

As stated above, our team adjusted the price increases to be in line with realistic economic,
supply/demand conditions Dixons industry will face regionally post-acquisition.

1981
0.48%

Adjusted Price Increases (year over year)

1982
1983
1984
Average
0.48%
8.00%
8.00%
4.24%

We performed a sensitivity analysis on a price increase adjustments impact on the NPV of the
investment with differing WACC calculations.

Price
Adjustment
Increase

NPV Sensitivity Analysis Without Laminate

WACC
($5,035)
12.1%
13.1%
14.1%
15.1%
4%
-$7,907
-$8,045
-$8,168
-$8,278
5%
-$6,992
-$7,201
-$7,384
-$7,547
6%
-$6,078
-$6,358
-$6,601
-$6,817
7%
-$5,163
-$5,514
-$5,818
-$6,086
8%
-$4,248
-$4,670
-$5,035
-$5,355
9%
-$3,334
-$3,827
-$4,252
-$4,624
10%
-$2,419
-$2,983
-$3,469
-$3,894
11%
-$1,505
-$2,139
-$2,686
-$3,163
12%
-$590
-$1,296
-$1,903
-$2,432

NPV Sensitivity Analysis With Laminate

WACC
$8,229
12.1%
13.1%
14.1%
15.1%
4%
$7,670
$6,286
$5,097
$4,063
5%
$8,584
$7,129
$5,880
$4,794
6%
$9,499
$7,973
$6,663
$5,525
Price
7%
$10,413
$8,816
$7,446
$6,255
Adjustment
8%
$11,328
$9,660
$8,229
$6,986
Increase
9%
$12,243 $10,504
$9,012
$7,717
10%
$13,157 $11,347
$9,795
$8,447
11%
$14,072 $12,191 $10,578
$9,178
12%
$14,986 $13,035 $11,361
$9,909

16.1%
-$8,379
-$7,694
-$7,009
-$6,324
-$5,639
-$4,954
-$4,269
-$3,584
-$2,899

16.1%
$3,154
$3,839
$4,524
$5,209
$5,894
$6,579
$7,264
$7,949
$8,634

From 1970-79, the industry saw and average price increase of 14.2%. The price elasticity of demand is
1.07 suggesting that the industry demand is sensitive to price increase, but their end users end up taking
price because this is a necessary product for their manufacturing. This suggests that the price increases
mentioned above could be conservative, and the NPV analysis has room for upside.

Year
CAGR

Sales of
Sodium
Domestic
Chlorate
Capacity
7.9%
6.0%

Demand vs
Average
Supply (% Demand %
Price
difference)
increase
17.05%
-8.05%
8.37%

Supply %
increase
6.02%

Price
Elasticity
Price %
of
increase
Demand
14.20%
1.07 Averages

4|Page

Appendix 2- Computation for Effective Tax

Calculated effective tax rate for Dixon Corporation
Exhibit 7

1975
Sales
Cost of goods sold
Selling and administrative
Research
Interest
Taxes

Financial Statements of Dixon Corporation (000s)

For the Years Ended December 31,

1976
1977
1978
1979

$19,128
$14,085
$1,952
$325
$400
$2,366

$23,830
$16,889
$2,308
$388
$320
$3,925

$28,348
$19,950
$2,824
$593
$240
$4,741

$34,770
$24,467
$3,291
$682
$160
$6,170

$42,259
$29,185
$4,436
$716
$80
$7,842

Taxes

1,125

1,878

2,285

2,932

3,818

Tax %
Avg. Tax %

47.5%
48.0%

47.8%

48.2%

47.5%

48.7%

Appendix 3 S&P 500 returns

http://www.forecast-chart.com/historical-sp-500.html
S&P 500 Index: Annual Returns
Year Percent
Year Percent
1951
16.3
1970
0.1
1952
11.8
1971
10.8
1953
-6.6
1972
15.6
1954
45
1973
-17.4
1955
26.4
1974
-29.7
1956
2.6
1975
31.5
1957
-14.3
1976
19.1
1958
38.1
1977
-11.5
1959
8.5
1978
1.10%
1960
-3
1979
12.30%
1961
23.1
1980
25.8
1962
-11.8
1981
-9.7
1963
18.9
1982
14.8
1964
13
1983
17.3
1965
9.1
1984
1.4
1966
-13.1
1985
26.3
1967
20.1
1986
14.6
1968
7.7
1987
2
1969
-11.4
1988
12.4

Year
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

Percent
27.3
-6.6
26.3
4.5
7.1
-1.5
34.1
20.3
31
26.7
19.5
-10.1
-13
-23.4
26.4
9
3
13.6
3.5

Year
2008
2009
2010
2011
2012

Percent
-38.5
23.5
12.8
0
13.4

5|Page

Appendix 4 Scenarios Used in Analysis

Scenarios

CapEx (Low)
CapEx (High)

475
600

Implied Effective Tax Rate

Corporate Tax Rate

48.0%
34%

LT Growth Rate (Low)

LT Growth Rate (High)

1%
3%

Scenarios
Power Reduction (Low)
Power Reduction (High)

15%
20%

Laminate Cost
Depreciation (SL) Yrs
Depreciation per year

2250
10
225

Appendix 5 Historical Market Premium

Source: NYU Stern http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html

Year
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

Stocks
23.80%
10.81%
-8.24%
3.56%
14.22%
18.76%
-14.31%
-25.90%
37.00%
23.83%
-6.98%
6.51%
18.52%
31.74%
-4.70%
20.42%
22.34%
6.15%
31.24%
18.49%
5.81%
16.54%
31.48%

T.Bills
4.33%
5.26%
6.56%
6.69%
4.54%
3.95%
6.73%
7.78%
5.99%
4.97%
5.13%
6.93%
9.94%
11.22%
14.30%
11.01%
8.45%
9.61%
7.49%
6.04%
5.72%
6.45%
8.11%

T.Bonds Stocks
-1.58%
$3,333.69
3.27%
$3,694.23
-5.01%
$3,389.77
16.75%
$3,510.49
9.79%
$4,009.72
2.82%
$4,761.76
3.66%
$4,080.44
1.99%
$3,023.54
3.61%
$4,142.10
15.98%
$5,129.20
1.29%
$4,771.20
-0.78%
$5,081.77
0.67%
$6,022.89
-2.99%
$7,934.26
8.20%
$7,561.16
32.81%
$9,105.08
3.20%
$11,138.90
13.73%
$11,823.51
25.71%
$15,516.60
24.28%
$18,386.33
-4.96%
$19,455.08
8.22%
$22,672.40
17.69%
$29,808.58

T.Bills
$196.10
$206.41
$219.96
$234.66
$245.32
$255.01
$272.16
$293.33
$310.90
$326.35
$343.09
$366.87
$403.33
$448.58
$512.73
$569.18
$617.26
$676.60
$727.26
$771.15
$815.27
$867.86
$938.24

T.Bonds
$278.01
$287.11
$272.71
$318.41
$349.57
$359.42
$372.57
$379.98
$393.68
$456.61
$462.50
$458.90
$461.98
$448.17
$484.91
$644.04
$664.65
$755.92
$950.29
$1,181.06
$1,122.47
$1,214.78
$1,429.72

Trailing
10-year
Market rolling
Premium average
19.47%
5.55%
-14.80%
-3.13%
9.68%
14.81%
-21.04%
-33.68%
31.01%
18.86%
-12.11%
-0.42%
8.58%
20.52%
-19.00%
9.41%
13.89%
-3.46%
23.75%
12.45%
0.09%
10.09%
23.37%

8.13%
8.19%
8.09%
4.34%
4.41%
5.87%
2.09%
0.25%
1.21%
1.70%
-0.02%
1.18%
0.28%
1.52%
1.17%
2.22%
2.57%
1.05%
4.78%
8.62%
6.05%
5.32%
8.27%

6|Page

Appendix 6: Real Option Value

Laminate Investment Option Valuation
1
1980
CAPX
Manufacturing Costs
Power
Graphite
After-tax Interest
Depreciation
Cash Flows
PV Option Cash Flows
NPV of Laminate Option

2
3
4
For the Years Ended December 31,
1981
1982
1983

5
1984

$2,250
$0
$0
$132
$2,118
$1,856
$4,996

$1,160
$791
$132
$225
$2,308
$1,772

$1,408
$875
$132
$225
$2,640
$1,776

$1,579
$940
$132
$225
$2,876
$1,695

$1,767
$992
$132
$225
$3,116
$1,609

Pro Forma Financial Statements for the Collinsville Plant Without Laminate (000s)
Expected
12/31 1979
EBIT
NOPAT
After-tax Interest
Depreciation
CA
CL
NWC
Change in NWC
CapEx
FCFF
PV FCFF
PV of Terminal Value
Sum of PV of FCFs
Purchase Price
NPV
NPV of Acquisition,
Including Laminate
Option

$2,273
873
$1,400

1980
$833
$433
$702
$1,060
$1,926
730
$1,196
$204
$600
$1,799
$1,576

For the Years Ended December 31,

1981
1982
1983
$13
($802)
($1,025)
$7
($417)
($533)
$702
$702
$702
$1,110
$1,160
$1,210
$2,436
$2,865
$3,097
924
1087
1175
$1,512
$1,778
$1,922
($316)
($266)
($144)
$600
$600
$600
$903
$579
$635
$693
$390
$374

1984
($1,429)
($743)
$702
$1,270
$3,339
1267
$2,072
($150)
$600
$479
$247

Terminal

$3,684

$6,965
($12,000)
($5,035)
($40)

7|Page