Dixon Corporation Case Study
WACC
Dixon is entering into the sodium chlorate business by acquiring the Collinsville plant, which is different from the current core operations of Dixon Corporation. Therefore, we cannot use the firm’s existing equity beta in the calculation of the WACC. Instead, we used “pure plays” as comparable firms in order to estimate the unlevered asset beta for the project. From the list of companies provided, we chose the following specialty sodium chlorate producers from Exhibit 5 for our comp set:
1. Pennwalt
2. Kerr-McGee
3. International Minerals and Chemicals
4. Georgia-Pacific
5. Brunswick Chemical
6. Southern Chemical
These companies are the best indicators of the project’s beta because they are all specialty sodium chlorate producers and best represent the industry into which Dixon is entering.
Following this step, we unlevered each firm’s equity beta based on their respective capital structure. Then we averaged the 6 unlevered asset betas to get an unlevered beta for the sodium chlorate industry of .8827.
To determine the weights on equity and debt used in our WACC calculation, we averaged the D/E from the project’s five comps using the market value of equity and the book value of debt for each firm given in Exhibit 5. We used the new average D/E ratio of 30.73% to re-lever the asset beta of the comp set. This new D/E ratio, along with the average unlevered beta produced by the comp set, gives the total equity beta for Dixon of 1.1540.
Before finding the WACC, we found the cost of equity using the CAPM equation for a value of 17.58%. We used the given 10 year treasury rate of 9.5% as the risk-free rate. The market risk premium was given at 7%, and we used the previously calculated equity beta of 1.1540.
Finally, we determined a WACC of 15.01%. The factors used to calculate the WACC were the cost of equity, weighted value of equity, cost of debt, weighted value of debt, and the tax rate. We deducted operating expenses and other income from the sales revenue which results in the pre-tax income. We divided the pretax income by the tax expense to find the tax rate of 47.55%. The cost of debt was given at 11.25% which is the rate at which Dixon will borrow the $8 million.
APV All-Equity Cost of Capital
To determine the all-equity cost of capital of 15.68%, we used the CAPM equation using the average unlevered beta derived from the comp set. Again, we cannot use Dixon’s beta because we are entering into a business that is separate from our core operations. We used the risk-free rate of 9.5% and market risk premium