du pont titanium dioxide - assumptions

Du Pont Titanium Dioxide - Assumptions

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985- - - - - - - - - - - - - -

Size of Market 752 774 798 822 846 872 898 925 952 981 1010 1041 1072Cost of New Capacity/Ton 900 927 955 983 1013 1043 1075 1107 1140 1174 1210 1246 1283Pre-Tax Operating Expense/Ton 330 390 460 540 580 620 660 690 710 740 770 810 850Market Share Maintain 0.35 0.40 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 Growth 0.35 0.40 0.47 0.47 0.51 0.52 0.52 0.55 0.58 0.59 0.62 0.62 0.64Average Selling Price/Ton Maintain 555 665 760 890 955 1015 1070 1120 1170 1210 1270 1320 1370 Growth 540 640 750 880 950 1010 1070 1130 1190 1250 1310 1370 1430Capacity Maintain 325 340 350 360 370 381 392 404 416 428 441 455 468 482 Growth 325 350 375 400 421 443 475 505 530 552 579 616 645 685

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 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

Unit Sales (1000 Tons) 263 310 325 325 325 325 325 325 325 325 325 325 325Sales 100000 146076 205884 247000 289250 310375 329875 347750 364000 380250 393250 412750 429000 445250Costs 86856 120744 149500 175500 188500 201500 214500 224250 230750 240500 250250 263250 276250Pre-tax Profits 59220 85140 97500 113750 121875 128375 133250 139750 149500 152750 162500 165750 169000Taxes 28426 40867 46800 54600 58500 61620 63960 67080 71760 73320 78000 79560 81120After-tax Profits 30794 44273 50700 59150 63375 66755 69290 72670 77740 79430 84500 86190 87880 Plus Depreciation 0 0 0 0 0 0 0 0 0 0 0 0 0Operating Cash Flow 30794 44273 50700 59150 63375 66755 69290 72670 77740 79430 84500 86190 87880 Less Change in NWC 9215 11962 8223 8450 4225 3900 3575 3250 3250 2600 3900 3250 3250 Less Change in FA 0 0 0 0 0 0 0 0 0 0 0 0 0 Plus Investment Tax Credit 0 0 0 0 0 0 0 0 0 0 0 0 0Recovery Net Working Capital 69050 Plant & Equipment 0Total Cash Flow 21579 32311 42477 50700 59150 62855 65715 69420 74490 76830 80600 82940 153680

Du Pont Titanium Dioxide - Maintain Strategy

Maintain Strategy

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

Unit Sales (1000 Tons) 263 310 359 370 381 392 404 416 428 441 455 468 482Sales 100000 146076 205884 272916 329211 363569 398286 432387 466200 501228 534155 577215 618354 660888Costs 86856 120744 165186 199746 220806 243288 266706 287213 304164 326673 349965 379445 410040Pre-tax Profits 59220 85140 107730 129465 142763 154998 165681 178988 197064 207482 227250 238910 250848Taxes 28426 40867 51710 62143 68526 74399 79527 85914 94591 99591 109080 114677 120407After-tax Profits 30794 44273 56020 67322 74237 80599 86154 93074 102473 107890 118170 124233 130441 Plus Depreciation 0 0 0 0 0 0 0 0 0 0 0 0 0Operating Cash Flow 30794 44273 56020 67322 74237 80599 86154 93074 102473 107890 118170 124233 130441 Less Change in NWC 9215 11962 13406 11259 6871 6944 6820 6763 7006 6585 8612 8228 8507 Less Change in FA 13500 9270 9550 9830 11143 11473 12900 13284 13680 15262 16940 16198 17962 Plus Investment Tax Credit 1350 927 955 983 1114 1147 1290 1328 1368 1526 1694 1620 1796Recovery Net Working Capital 112178 Plant & Equipment 170992Total Cash Flow 9429 23968 34018 47216 57336 63330 67724 74355 83156 87569 94312 101427 388938 Incremental Cash Flow -12150 -8343 -8459 -3484 -1814 475 2009 4935 8666 10739 13712 18487 235258

Du Pont Titanium Dioxide - Growth Strategy

Growth Strategy

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

Unit Sales (1000 Tons) 263 310 375 386 431 453 467 509 552 579 626 645 686Sales 100000 142128 198144 281295 339979 409887 457974 499647 574888 657070 723488 820322 884225 981094Costs 86856 120744 172528 208624 250247 281133 308194 351038 392034 428305 482174 522790 583168Pre-tax Profits 55272 77400 108767 131356 159640 176842 191454 223850 265037 295183 338148 361435 397926Taxes 26531 37152 52208 63051 76627 84884 91898 107448 127218 141688 162311 173489 191005After-tax Profits 28741 40248 56559 68305 83013 91958 99556 116402 137819 153495 175837 187946 206922 Plus Depreciation 0 0 0 0 0 0 0 0 0 0 0 0 0Operating Cash Flow 28741 40248 56559 68305 83013 91958 99556 116402 137819 153495 175837 187946 206922 Less Change in NWC 8426 11203 16630 11737 13982 9617 8335 15048 16437 13283 19367 12781 19374 Less Change in FA 22500 23175 23875 20643 22286 33376 32250 27675 25080 31698 44770 36134 51320 Plus Investment Tax Credit 2250 2318 2388 2064 2229 3338 3225 2768 2508 3170 4477 3613 5132Recovery Net Working Capital 176219 Plant & Equipment 394782Total Cash Flow 66 8187 18441 37989 48974 52302 62196 76446 98811 111683 116177 142645 712361 Incremental Cash Flow -21513 -24124 -24035 -12711 -10176 -10553 -3519 7026 24321 34853 35577 59705 558681

Du Pont Titanium Dioxide - Excess Capacity• Growth Strategy

Year Excess Capacity1973 86.80 tons1974 65.40 tons1975 24.94 tons1976 34.66 tons1977 11.54 tons1978 21.56 tons1979 38.04 tons1980 18.50 tons1981 0.00 tons1982 0.00 tons1983 10.00 tons1984 0.00 tons1985 1.00 ton

• Maintain StrategyYear Excess Capacity1973 76.80 tons1974 40.40 tons1975 1.00 ton1976 0.00 tons1977 0.00 tons1978 0.00 tons1979 0.00 tons1980 0.00 tons1981 0.00 tons1982 0.00 tons1983 0.00 tons1984 0.00 tons1985 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

-100000

0

100000

200000

300000

400000

500000

600000

700000

0.00 0.05 0.10 0.15 0.20 0.25

Discount Rates

Net

Pre

sent

Val

ues

MaintainGrowth

Du Pont Titanium Dioxide - Sensitivity Analysis

Variable (% of Projection) NPV (10%) Maintain NPV (10%)Growth

Base Case (100%) 62,458 140,037

Costs (140%) -616 10,217

Sales Price (75% ) -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%) andCost of Capital (150%, or 15%/10%)

5,540 5,686

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 Challenge Change

Less than 1,000 Low NA1,000 to 1,800 Moderate 100Greater than 1,800 High 50

• Unfair Competition?

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:

• 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

N

t t

t

rCFPV

0 )1(

Bond (Debt) Valuation

• The price of bonds in the market place is the present value of the cash flows that bondholders have claim to:

• These cash flows consist generally of two components, interest and principal. They are generally divided as follows:

• That is, interest is paid every period, and the principal is paid at maturity, when the bond comes due.

N

tt

d

tdd r

CFPV

1

,

)1(

Nd

N

tt

dd r

Pr

IPV)1()1(1

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).


• 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-to-maturity of 10%. Assuming interest is paid annually and the bond is in equilibrium,– What is the price of the bond?

– What is its current yield?

• Current Yield = I/PV =

– What is its expected capital gains yield?

• Capital Gains Yield = [(PV1-PV0)/ PV0] =

?)10.1(

000,1)10.1(

10010

10

1

ttdPV


• 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?

Current Yield = I/PV =

Capital Gains Yield = [(PV1-PV0)/ PV0] =

• What would cause the yield to maturity to be 12% instead of 10%?

?)12.1(

000,1)12.1(

10010

10

1

ttdPV

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?


• 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

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0

Risk

Retu

rn

Bond Valuation (Continued)Sensitivity of Bond Prices to Changing Interest Rates

0.00

50.00

100.00

150.00

200.00

250.00

300.00

4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00%

Yield to Maturity

Pric

e of

Bon

d R

elat

ive

to $

100

Beg

inni

ng P

oint


0

200

400

600

800

1000

1200

Bas

is P

oint

Spr

eads

Aa2/AA A2/A Baa2/BBB Ba2/BB B2/BS1

S4

S7

Ratings

Years to Maturity

Spreads Between Corporate and Government Bonds

Stock Valuation

• The price of stocks in the market place is the present value of the cash flows that stockholders have claim to:

• These cash flows consist generally of two components, dividends and capital gains. They are generally divided as follows:

N

tt

s

tss r

CFPV

1

,

)1(

Ns

NsN

tt

s

ts r

PVr

DivPV)1()1(

,

10,

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?


Risk Return Relationship

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0

Risk

Retu

rn


• 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

• 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

grDivPVs

s 1

0,

gPVDivr

ss

0,

1


• 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?


• 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

• 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?

NPVGOr

EPSPVs

s 10,


• 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

• 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

)(*)(*

1 grrrROEb

EPSNPVGOss

s

Stock Valuation (Continued)AssumptionsROE 20.00%Retention Ratio 40.00%Payout Ratio 60.00%Required Return 15.00%Growth 8.00%Expected Earnings without Investment 2.50$

Time 0 1 2 3 4 5 6 …. ….Earnings with No New Investment 2.50$ 2.50$ 2.50$ 2.50$ 2.50$ 2.50$ 2.50$ 2.50$ Present Value of Earnings 16.67$

Amount Retained (1.00)$ Additional Earnings from Investment 0.20$ 0.20$ 0.20$ 0.20$ 0.20$ 0.20$ 0.20$ PV of Additional Earnings 1.33$ NPV of Additional Earnings 0.29$

Total Earnings 2.50$ 2.70$ 2.70$ 2.70$ 2.70$ 2.70$ 2.70$ 2.70$ Amount Retained (1.08)$ Additional Earnings from Investment 0.22$ 0.22$ 0.22$ 0.22$ 0.22$ 0.22$ PV of Additional Earnings 1.44$ NPV of Additional Earnings 0.27$

Total Earnings 2.50$ 2.70$ 2.92$ 2.92$ 2.92$ 2.92$ 2.92$ 2.92$ Amount Retained (1.17)$ Additional Earnings from Investment 0.23$ 0.23$ 0.23$ 0.23$ 0.23$ PV of Additional Earnings 1.56$ NPV of Additional Earnings 0.26$


• What would happen if the firm could make these investments indefinitely by retaining 40% of its earnings and producing ROEs of 20%?

• What would the price of the stock be?

• EPS1/rs + NPVGO = $2.5/.15 + $4.76 = $21.43

76.4$)08.15(.*15.)15.20(.*4.*50.2$

)(*)(*

1

grrrROEb

EPSNPVGOss

s

• How does that coincide with the earlier model

• How does the model we have just discussed relate to EVA, if it does?


43.21$)20.*4.15(.

50.1$10,

grDivPVs

s

du pont titanium dioxide - assumptions

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