Du Pont Titanium Dioxide - Assumptions
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Du Pont Titanium Dioxide - Assumptions 1972 Size of Market Cost of New Capacity/Ton Pre-Tax Operating Expense/Ton Market Share Maintain Growth Average Selling Price/Ton Maintain Growth Capacity Maintain Growth 1973 - 325 325 1974 - 1975 - 1976 - 1977 - 1978 - 1979 - 1980 - 1981 - 1982 - 1983 - 1984 - 1985 - 752 900 330 774 927 390 798 955 460 822 983 540 846 1013 580 872 1043 620 898 1075 660 925 1107 690 952 1140 710 981 1174 740 1010 1210 770 1041 1246 810 1072 1283 850 0.35 0.35 0.40 0.40 0.45 0.47 0.45 0.47 0.45 0.51 0.45 0.52 0.45 0.52 0.45 0.55 0.45 0.58 0.45 0.59 0.45 0.62 0.45 0.62 0.45 0.64 555 540 665 640 760 750 890 880 955 950 1015 1010 1070 1070 1120 1130 1170 1190 1210 1250 1270 1310 1320 1370 1370 1430 340 350 350 375 360 400 370 421 381 443 392 475 404 505 416 530 428 552 441 579 455 616 468 645 482 685 Du Pont Titanium Dioxide - Do Nothing Do Nothing - Stay at Existing Capacity ( 325,000 tons ) and Allow Sales to Grow Until Full Capacity is Reached 1972 Unit Sales (1000 Tons) Sales Costs Pre-tax Profits Taxes After-tax Profits Plus Depreciation Operating Cash Flow Less Change in NWC Less Change in FA Plus Investment Tax Credit Recovery Net Working Capital Plant & Equipment Total Cash Flow 100000 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 263 146076 86856 59220 28426 30794 0 30794 9215 0 0 310 205884 120744 85140 40867 44273 0 44273 11962 0 0 325 247000 149500 97500 46800 50700 0 50700 8223 0 0 325 289250 175500 113750 54600 59150 0 59150 8450 0 0 325 310375 188500 121875 58500 63375 0 63375 4225 0 0 325 329875 201500 128375 61620 66755 0 66755 3900 0 0 325 347750 214500 133250 63960 69290 0 69290 3575 0 0 325 364000 224250 139750 67080 72670 0 72670 3250 0 0 325 380250 230750 149500 71760 77740 0 77740 3250 0 0 325 393250 240500 152750 73320 79430 0 79430 2600 0 0 325 412750 250250 162500 78000 84500 0 84500 3900 0 0 325 429000 263250 165750 79560 86190 0 86190 3250 0 0 325 445250 276250 169000 81120 87880 0 87880 3250 0 0 82940 69050 0 153680 21579 32311 42477 50700 59150 62855 65715 69420 74490 76830 80600 Du Pont Titanium Dioxide - Maintain Strategy Maintain Strategy 1972 Unit Sales (1000 Tons) Sales Costs Pre-tax Profits Taxes After-tax Profits Plus Depreciation Operating Cash Flow Less Change in NWC Less Change in FA Plus Investment Tax Credit Recovery Net Working Capital Plant & Equipment Total Cash Flow Incremental Cash Flow 100000 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 263 146076 86856 59220 28426 30794 0 30794 9215 13500 1350 310 205884 120744 85140 40867 44273 0 44273 11962 9270 927 359 272916 165186 107730 51710 56020 0 56020 13406 9550 955 370 329211 199746 129465 62143 67322 0 67322 11259 9830 983 381 363569 220806 142763 68526 74237 0 74237 6871 11143 1114 392 398286 243288 154998 74399 80599 0 80599 6944 11473 1147 404 432387 266706 165681 79527 86154 0 86154 6820 12900 1290 416 466200 287213 178988 85914 93074 0 93074 6763 13284 1328 428 501228 304164 197064 94591 102473 0 102473 7006 13680 1368 441 534155 326673 207482 99591 107890 0 107890 6585 15262 1526 455 577215 349965 227250 109080 118170 0 118170 8612 16940 1694 468 618354 379445 238910 114677 124233 0 124233 8228 16198 1620 482 660888 410040 250848 120407 130441 0 130441 8507 17962 1796 101427 18487 112178 170992 388938 235258 9429 -12150 23968 -8343 34018 -8459 47216 -3484 57336 -1814 63330 475 67724 2009 74355 4935 83156 8666 87569 10739 94312 13712 Du Pont Titanium Dioxide - Growth Strategy Growth Strategy 1972 Unit Sales (1000 Tons) Sales Costs Pre-tax Profits Taxes After-tax Profits Plus Depreciation Operating Cash Flow Less Change in NWC Less Change in FA Plus Investment Tax Credit Recovery Net Working Capital Plant & Equipment Total Cash Flow Incremental Cash Flow 100000 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 263 142128 86856 55272 26531 28741 0 28741 8426 22500 2250 310 198144 120744 77400 37152 40248 0 40248 11203 23175 2318 375 281295 172528 108767 52208 56559 0 56559 16630 23875 2388 386 339979 208624 131356 63051 68305 0 68305 11737 20643 2064 431 409887 250247 159640 76627 83013 0 83013 13982 22286 2229 453 457974 281133 176842 84884 91958 0 91958 9617 33376 3338 467 499647 308194 191454 91898 99556 0 99556 8335 32250 3225 509 574888 351038 223850 107448 116402 0 116402 15048 27675 2768 552 657070 392034 265037 127218 137819 0 137819 16437 25080 2508 579 723488 428305 295183 141688 153495 0 153495 13283 31698 3170 626 820322 482174 338148 162311 175837 0 175837 19367 44770 4477 645 884225 522790 361435 173489 187946 0 187946 12781 36134 3613 686 981094 583168 397926 191005 206922 0 206922 19374 51320 5132 142645 59705 176219 394782 712361 558681 66 -21513 8187 -24124 18441 -24035 37989 -12711 48974 -10176 52302 -10553 62196 -3519 76446 7026 98811 24321 111683 34853 116177 35577 Du Pont Titanium Dioxide - Excess Capacity • Growth Strategy Year 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 Excess Capacity 86.80 tons 65.40 tons 24.94 tons 34.66 tons 11.54 tons 21.56 tons 38.04 tons 18.50 tons 0.00 tons 0.00 tons 10.00 tons 0.00 tons 1.00 ton • Maintain Strategy Year 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 Excess Capacity 76.80 tons 40.40 tons 1.00 ton 0.00 tons 0.00 tons 0.00 tons 0.00 tons 0.00 tons 0.00 tons 0.00 tons 0.00 tons 0.00 tons 0.00 tons Du Pont Titanium Dioxide - Competitive Positions • Du Pont – Operating Profit Margin = 40% – Debt/Total Capital = 9% • National Lead – Operating Profit Margin < 20% – Debt/Total Capital = 35% NPV Profiles NPV Profiles for Growth, Maintain, and Difference Strategies 700000 600000 500000 Net Present Values 400000 Maintain 300000 Growth 200000 100000 0 0.00 0.05 0.10 0.15 -100000 Discount Rates 0.20 0.25 Du Pont Titanium Dioxide - Sensitivity Analysis Variable (% of Projection) NPV (10%) Maintain NPV (10%)Growth 62,458 140,037 -616 10,217 -1 7,769 Market Share (87%) -1,417 61,554 NWC Recovery (0%) 49,965 108,994 Plant Recovery (0%) 36,702 80,573 NWC & Plant (0%) 24,209 49,530 NWC & Plant (0%) and Cost of Capital (150%, or 15%/10%) 5,540 5,686 Base Case (100%) Costs (140%) Sales Price (75% ) Antitrust Concerns? • Herfindahl-Hirshman Index (HHI) – The sum of the squared market shares of firms in the industry • Department of Justice (DOJ) 1984 merger guidelines – Range of HHI Category Less than 1,000 Low 1,000 to 1,800 Moderate Greater than 1,800 High • Unfair Competition? Challenge Change NA 100 50 Du Pont’s Strategy • Build Capacity to deter Competition • Price Titanium Dioxide to Capture the Market • Restrict Licenses of its Ilmenite Process Bond and Stock Valuation • The market value of the firm is the present value of the cash flows generated by the firm’s assets: CFt PV t t 0 (1 r ) N • The cash flows generated by the firm’s assets are divided among the investors who pay for the assets. If these investors include only debt and equity holders, the market value of the firm can be expressed as: PVfirm = PVdebt+ PVStock Bond (Debt) Valuation • The price of bonds in the market place is the present value of the cash flows that bondholders have claim to: N CFd ,t t 1 (1 rd )t PVd • These cash flows consist generally of two components, interest and principal. They are generally divided as follows: I P t t 1 (1 rd ) (1 rd ) N N PVd • That is, interest is paid every period, and the principal is paid at maturity, when the bond comes due. Bond Valuation (Continued) Terms: – Coupon Payment: the interest paid annually, or semiannually (I). Typically, these payments are fixed so that the interest paid each year is the same. – Principal: the amount borrowed, and repaid at maturity (P). – Coupon Rate: the annual interest payment divided by the principle (I/P) – Current Yield: the annual interest payment divided by the price (I/PV) – Capital Gains Yield: the change in price (over one year) divided by the price at the beginning of the year [(PV1-PV0)/ PV0] – Yield to Maturity: the return investors expect if they buy the bond and hold it until it matures. If the market is in equilibrium, the yield to maturity is also the return investors require given the bond’s risk (rd). Bond Valuation (Continued) • Numerical Example: Suppose a bond with 10 years to maturity has a coupon rate of 10%, a principal amount of $1,000, and a yield-tomaturity of 10%. Assuming interest is paid annually and the bond is in equilibrium, – What is the price of the bond? 100 1,000 ? t t 1 (1.10) (1.10)10 10 PVd – What is its current yield? • Current Yield = I/PV = – What is its expected capital gains yield? • Capital Gains Yield = [(PV1-PV0)/ PV0] = Bond Valuation (Continued) • Suppose now that everything else remains constant, but the yield to maturity is 12%. What are the price, the current yield, and the expected capital gains yield? 100 1,000 ? t 10 t 1 (1.12) (1.12) 10 PVd Current Yield = I/PV = Capital Gains Yield = [(PV1-PV0)/ PV0] = • What would cause the yield to maturity to be 12% instead of 10%? Bond Valuation (Continued) • The yield to maturity, the return investors expect, is linked to the return investors require, rd. • The required return, rd , is a function of – The real rate of return - the return investors require for deferring consumption (that is, the time value of money) – The expected rate of inflation - the compensation investors require to guard against losses in their purchasing power. – The risk premium - the compensation investors require to accept the possibility that their return will be lower than what they were promised. • If rd is 12%, not 10%, one or more of the three components of the required rate of return must be higher in the second instance than in the first. • Why is yield to maturity linked to rd? Bond Valuation (Continued) • Suppose the expected rate of return does not equal the required rate of return. If the bond above should be priced at $887 because the required rate of return is 12%, but it is priced at $1,000 to give an expected return of 10%, investors are not being compensated for the risk that they bear. – The NPV from buying the bond will be negative (887-1,000), so new investors will not buy. – The NPV from selling the bond will be positive (1,000-887), so existing investors will want to sell. – The combination of new investors not buying and existing investors wanting to sell will cause the price of the bond to fall. – How far? Why? Bond Valuation (Continued) Risk Return Relationship 20.00% 18.00% 16.00% 14.00% Return 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 0.0 0.2 0.4 0.6 0.8 1.0 Risk 1.2 1.4 1.6 1.8 2.0 Bond Valuation (Continued) Sensitivity of Bond Prices to Changing Interest Rates Price of Bond Relative to $100 Beginning Point 300.00 250.00 200.00 150.00 100.00 50.00 0.00 4.00% 6.00% 8.00% 10.00% Yield to Maturity 12.00% 14.00% 16.00% Bond Valuation (Continued) Spreads Betw een Corporate and Government Bonds Basis Point Spreads 1200 1000 800 600 400 S7 200 S4 S1 0 Aa2/AA A2/A Baa2/BBB Ratings Ba2/BB B2/B Years to Maturity Stock Valuation • The price of stocks in the market place is the present value of the cash flows that stockholders have claim to: N CFs ,t t 1 (1 rs )t PVs • These cash flows consist generally of two components, dividends and capital gains. They are generally divided as follows: PVs ,0 PVs , N Div t t t 1 (1 rs ) (1 rs ) N N Stock Valuation (Continued) • What are the differences between bond and stock cash flows? – Interest vs Dividends • Interest is paid before dividends. • Interest is generally fixed ; dividends are variable. • Interest is a contractual obligation; dividends are discretionary. – Principal vs. Future Stock Prices • Principal is contractually binding to the firm; future stock prices are not. • In liquidation, claims to both principle and interest must be satisfied before payments can be made to stockholders • What do these differences imply about potential differences between rs and rd? Stock Valuation (Continued) Risk Return Relationship 20.00% 18.00% 16.00% 14.00% Return 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 0.0 0.2 0.4 0.6 0.8 1.0 Risk 1.2 1.4 1.6 1.8 2.0 Stock Valuation (Continued) • If, for simplicity, we assume that dividends grow forever at a constant rate, g, and that that rate is lower than the required rate of return on the stock, rs, then the present value of the dividends and future stock price can be expressed as Div1 PVs , 0 rs g • This says that the price of the stock today equals the expected dividend one year from today (Div1) divided by the difference between the required rate of return and the constant growth rate (rs-g) • Under these same assumptions, the required return on the stock could be estimated as Div1 rs g PVs , 0 Stock Valuation (Continued) • Suppose the expected dividend next period (D1) is $1.50, the expected constant growth rate (g) is 8%, and the required return (rs)on the stock is 15%. What is the price of the stock today – P0 = D1/(rs-g) = $1.50/(.15-.08) = $21.43 • What are the expected current (or dividend) yield and capital gains yield? – Current Yield = D1/P0 = $1.50/$21.43 = .07 or 7% – Capital Gains Yield = ? • How does the stock price relate to the NPV of projects undertaken by the firm? Stock Valuation (Continued) • How does the stock price relate to capital budgeting decisions of the firm? The NPV of projects undertaken by firms is reflected in stock prices as follows PVs , 0 EPS1 NPVGO rs • The first component, EPS1/rs, is the price of the stock if equity cash flows (or earnings) remain constant forever. The second component is the expected NPV from future growth opportunities. • What determines whether NPVGO is positive or negative? Stock Valuation (Continued) • By setting the two stock pricing relationships equal to each other and recognizing that (Div1/EPS1) equals 1-b, where b is the firm’s retention ratio, and g is the ROE*b, we can express NPVGO as NPVGO EPS1 b * ( ROE rs ) rs * (rs g ) • The above relationship tells us that NPVGO will be positive so long as the ROE on the investment exceeds the required rate of return,rs Stock Valuation (Continued) Assumptions ROE Retention Ratio Payout Ratio Required Return Growth Expected Earnings without Investment Time Earnings with No New Investment Present Value of Earnings Amount Retained Additional Earnings from Investment PV of Additional Earnings NPV of Additional Earnings Total Earnings Amount Retained Additional Earnings from Investment PV of Additional Earnings NPV of Additional Earnings Total Earnings Amount Retained Additional Earnings from Investment PV of Additional Earnings NPV of Additional Earnings $ 20.00% 40.00% 60.00% 15.00% 8.00% 2.50 0 $ $ 1 2.50 $ $ (1.00) $ 1.33 4 2.50 $ 5 2.50 $ 6 …. 2.50 $ 2.50 …. $ 2.50 0.20 $ 0.20 $ 0.20 $ 0.20 $ 0.20 $ 0.20 $ 0.20 $ 2.50 2.70 $ (1.08) $ 1.44 2.70 $ 2.70 $ 2.70 $ 2.70 $ 2.70 $ 2.70 0.22 $ 0.22 $ 0.22 $ 0.22 $ 0.22 $ 0.22 2.92 $ (1.17) $ 1.56 2.92 $ 2.92 $ 2.92 $ 2.92 $ 2.92 0.23 $ 0.23 $ 0.23 $ 0.23 $ 0.23 0.29 $ $ $ $ 3 2.50 $ 16.67 $ $ 2 2.50 $ 0.27 $ 2.50 $ 2.70 $ $ $ $ 0.26 Stock Valuation (Continued) • What would happen if the firm could make these investments indefinitely by retaining 40% of its earnings and producing ROEs of 20%? NPVGO EPS1 b * ( ROE rs ) rs * (rs g ) .4 * (.20 .15) $2.50 * $4.76 .15 * (.15 .08) • What would the price of the stock be? • EPS1/rs + NPVGO = $2.5/.15 + $4.76 = $21.43 Stock Valuation (Continued) • How does that coincide with the earlier model PVs ,0 Div1 $1.50 $21.43 rs g (.15 .4 * .20) • How does the model we have just discussed relate to EVA, if it does?
