Dow Chemical Case

Dow Chemical Case Question 1 polyethene is the worlds most widely used plastic. Poly ethylene plastics principal exertion was in packaging, from trash bags to milk jugs. It was widely used in the manufacture of everything from trash bags, picnic stonecutter and garbage pails, to plastic toys. Polyethylene to a fault replaced glass, wood, and metal in certain applications. in that location were 3 types of polyethylene, thinness polyethylene, High density polyethylene and Low linear density polyethylene. Polyethylene produced from ethylene. Ethylene is produced from oil or natural gas.Ethylene go downs separated either naphtha molecules (derived from crude oil) or ethane molecules (derived from natural gas). The ethylene derived from this cognitive process was used to produce polyethylene. The critical success factors in this business were slap-up intensive and economies of scale. Polyethylene was a global commodity product and pricing worldwide typically fell into a narrow band. The request for polyethylene was large because it was the worlds most widely used plastic and polyethylene customers were typically small and medium-sized plastic processing companies.The heroic Risks in the industry * The raw material hazard grab naphtha (the raw material derived from crude oil) required much to a greater extent than energy, manufacturing intensity, and equipment than cracking ethane (derived from natural gas). fork everywhere of primary materials and electricity atomic number 18 crucial to success of polyethylene production. * Cost try large plant sizes and the withdraw for economies of scale rendered the ethylene industry highly capital intensive. A plant for cracking ethane was estimated to hundreds of millions and the toll for a plant for cracking naphtha is double.Capacity additions or reductions could significantly affect balance of stretch forth and demand, influencing capacity utilization rates, wrongs, and profit margins. * Ethylene p rofitability was tightly links to its global operating rate. The ethylene business links to oil companies, governments, pure chemical companies, conglomerates, private investors, and joint ventures. * Competition of polyethylene industry in genus genus genus genus Argentina and in the global market. The government operator was directly or indirectly punting capital intensive ethylene plants in order to stimulate downstream business.Some of countries, the government bring in the enthronement. * The margins for producers of ethylene and first-order derivatives (mostly plastics) were highly correlated because the producers for them were highly integrated. Question 2 The legs of the send off * point 1 twisting taking control of PBB, which comprised the ethylene cracker and polyethylene plant, and then upgrading the facilities in order to make them internationally competitive * Stage 2 involved acquiring Polisurs deuce polyethylene plants * Stage 3 involved building a new ethyle ne cracker and a polyethylene plantThese three salutes are closely related to separately other. The next constitute would be reached altogether if the previous re-creates achieved, and the followed stages learn the success of the previous stages. Acquiring PBB offers Dow the opportunity to enter Argentina market, and this is the first step for Dow to take over control of Bahia Blancas polyethylene activities. Dow is wish wellding non only for PBB in the privatization, but also an boilers suit plan for the organisement of Dows polyethylene business in Argentina.Dow pass on decide on the outlay to bid for PBB in the upcoming privatization, the price is based on the valuation of the entire intention (stage 1, 2 and 3). The three stages are one big drift. Dows bid for PBB should not be based livelong on the look upon of Stage 1 of the project. Gaining control of PBB would be the first step in the project. tho taking all the factors discussed above into consideration, D ow should nurse all the 3 stages in order to bid on the PBB project. Dow believed that it had the opportunity to become the number-one player in the Latin American polyethylene industry.To achieve this goal, Dow would also deem to acquire Polisurs two polyethylene plants (stage 2) and expand existing capacity. The expansion of its polyethylene capacity in Bahia Blanca would require the company to build a world-class competitive cracker (stage 3). Doing so would nearly soprano PBBs ethylene capacity. Therefore, Dow had to not only consider what to bid for PBB in the privatization, but also develop an overall plan for the development of Dows polyethylene business. Dow had to incorporate the terminal protect of each stage of the project.Question 3 The followings are the arguments that support the acquisition of PBB 1. The social unit project will summation Dow stockholders wealth. As a public company, the first aim of the management team is to emergence the shareholder wealth. The project proposed by the management team is definitely consistent with this goal. And bidding on the PBB is the first stage of the whole project. The exact increase in shareholders equity may be various at this omen as it depends on lots of other factors ( we will discuss the risk of valuation thought the whole case. , but in general, the management team is confident in the emerging outlook. 2. The other important strategical purpose of acquiring PBB is that it is the first stage towards consolidating all Bahia Blancas polyethylene activity under Dows control. The 3-stage project will make Dow to be the leading company of polyethylene in Argentina, charge in Latin America because of its MNC background. This will have a long term positive influence in Dows stock price as well as shareholders equity. 3. Also, as indicated in the case, the demand of polyethylene will increase in the next couple stratums.Argentina is an emerging market, which is facing a fast transformation. D ows vice president anticipated continued improvement in standards of living, which will lead to increase demand for polyethylene in Argentina, as well as in Latin America. The judge reaping in polyethylene demand made PBB a potentially attractive acquisition. 4. PBB right now is a government controlled complex which is going to privatize. For Dow, it is a perfect opportunity to build long term descent with Argentina government. It will give Dow more opportunities in the market of Argentina and Latin America. Question 4The followings are the mains risks of the project for Dow beyond the general industry risks discussed in Question 1 1. Country risk. Argentina is an emerging market. It is widely agreed that when we estimate the risk of emerging market by using the conventional model like CAMP, the result also unfavorable. Some reasons are the market is highly concentrated and integrated. And also the pastoral risk cannot be diversified. So it brings the uncertainty to Dows valuat ion. 2. Political risk. Political risk is occasion of country risk. It is identified as the potentially adverse continue a countrys milieu has on a firms future immediate payment flows.And it will affect Dows future expected returns and valuation measures. If thither is some major political unrest in Argentina, the government expropriates PBB, Dow will face a significant loss. Also, if the Argentina government default on its debt, Dow would face the bad debt which is an big cost and will drag down the expected hard currency flows. 3. Economics risk The privatization in Argentina was the progress to control the fiscal problems, like hyperinflation, stagflation and massive fiscal deficits. As an emerging country, Argentina had not developed a healthy financial market within the country.The unstable economy would lead to a huge possibility of default. Another possible aspect was the economics risk of the world. If there was an economics downturn, the huge coronation of the proj ect would worth less and Dow will facing difficulties to rise equity to finance the project. 4. upset(prenominal) risk (1) upset(prenominal) shortage of energy. The industry is really energy intensive. If there is a energy shortage such as the decreased supply of oil, the whole project will face negative return. (2) Unexpected rise in uncertain cost, such as transportation cost.The unexpected rise in variable cost will have negative impingement on Dows hard change flow. The decrease of expected currency flow will lead the decrease value of the project. (3) There are 3 stages of the whole project. If one of them did not work well, the overall goal will be affected and the whole project would have the risk of failure. Question 5 habituated in the case that Dows cost of capital for similar U. S. based projects is 10%, thus we chose to use NPV to gauge the different stages of the project, by dismissing each years expected cash flow (Exhibit 9, 10 & 11) to the base year-1995. Stage 1 Valuation Given in the case, Dow is bidding on the sale of 51% of PBB, therefore, if we calculate the Present Value of the cash flow, Dow should rule 51%. Dows integrality investments for PBB Ethylene cracker and PBB Polyethylene cracker in the midst of 1996 and 2000 are $128. 9 million and $28 million in Exhibit 7 from the case. If we compare these figures with Exhibit 9A & 9B investment add up between 1996 and 2000, they are the same (shown in put off 1) this means that the cash flow of PBB in bear witness 9A is the cash flow after only deducting the investment from Dow.So, we add back Dows investment to desexualize the actual cash flow of PBB. Since Dows share in PBB is 51%, it pulsates 51% of PBBs cash flow and we rebate the cash flow. Next we calculate the sum of Present Value of Dows investment in each year, and subtract it from Dows 51% share in PBB. This number reflects the actual engagementwork cash flow been distributed to Dow. The followings summarize th e steps of the thinking process Step 1 Add back Dows investment to PBBs cash flow, this gives the total future cash flow to be distributed among Dow (Dow owns 51% of PBB) and other owners.Step 2 Find the PV of total future cash flows Step 3 emit the 51% of the PV of total future cash flow to Dow Step 4 Deduct PV of Dows investment from Step 3 The value of Stage 1 is $345. 71 million as shown in Table 2. Stage 2 Valuation In Stage 2, we took polyethylene CFs directly from Exhibit 10, and discount them by appropriate discount rate, and summing up these PV of the cash flows we get the value of Stage 2, $399. 76 million. Another loony toons worth mentioning is the calculation of the terminal value in 2010. Given in the case, the growth is 3. % constant for the project, we took the cash flow in 2010, which is $82 million multiplied it by (1+g)/(k-g), and discounted it by 16 years to get the posture value. Stage 3 Valuation Stage 3 involves building a new ethylene cracker and a polyeth ylene plant. We summed up the total cash flows of them and find PV of the cash flows in each year. The total of all the PV of the cash flows is the value of Stage 3, $ 993. 69 million shown in Table 4. this instant we have the value for each stage, and we get the total of the project, it is worth $1739. 16 million with the value of Stage 1, Stage 2 and Stage 3 are $345. 1 million, $399. 763 million and $993. 690 million respectively, under the premiss that each stage is successful just like Dow has planned. Question 6 There are two ways to do Discounted Cash Flow analysis in an international context. We can line up the discount rate by adding a countrys political risk premium or, adjust the cash flow of the project. In this question, we will discuss the appropriate method of the projects discount rate. In a country, the higher risk that investors perceived, the higher discount rate that should be applied to the projects cash flows.The risks we are talking about are not diversifiab le. Since November 1995, the Convertibility Law tied the peso to the U. S. dollar, even thought the market thinks the fixed exchange rate would last for several years, but as the executives of Dow, Virgnar and Marcer need to consider the possibility of future crises. Uncertainty about future currency thus will increase the discount rate of project in Argentina, which means that Dows cost of capital is increased. Possible impact of government policies relevant to foreign investments is another issue, example increased tax rate.This will leave Dow with a lower investment return than before. In practice it is often difficult to quantify the likelihood and impact of political risk on international investments given US and Argentine Yields in the case, we can adjust the discount rate by adding the sovereign yield spread between U. S. and Argentina. The idea is that the draw together spreads between two countries with same maturity reflects country risk. The country with the higher yield in this case is Argentina it offers approximately 10% more than the U. S yield shown in Exhibit 12.The reason behind that is Argentina has a higher country risk than U. S. , so it has to offer a higher yield in order to compensate the investors for taking additional risks. Therefore Dow should take these additional risks into consideration when evaluating the project. The adjusted discount rate for the project should be 20%, 10% ( cost of capital for similar U. S projects from Q5) + 10% (Argentinas country risk) and this change in the discount rate will have a big impact on the value of each stage in the project which we will examine later.There are two major advantages of adjusting the discount rate by adding the sovereign yield spread. One of the advantages is the countries bond yields are easy to find, observe and penetration, investors can easily calculate the country risk by subtracting the two bond yields. Another advantage is that the yield of bond is forward-looking, it do es not only incorporate todays condition, also the yield reflects the markets future expectation of a countrys risk and return so it is a good representation of cost of equity in a busy country.Salomon Smith Barney model is similar to the model that we just described, but with additional inputs and refinements. If we have more teaching from S&P country sovereign ratings, country ratings, and macro variables, we could adjust discount rate for the project more accurately. Furthermore, the political risk premium that we can add to the discount rate can be scaled up or down based on subjective scores for Dows access to capital, susceptibility of the project investment to Argentinas political risk and the importance of the investment for Dow.Therefore, the more relevant information we have, the more accurate discount rate we can construct to help evaluate the project. Question 7 The calculation process for is basically the same as in question 5, neglect here we use the cost of capital 20% instead of 10% to discount expected cash flow. Calculation shows in Table 5 (in Million U$). The project worth is $464. 734 which about only 20% of the project value if it located in US. The largely decrease in project value is due to the higher country risk in Argentina than in the US.The higher country risk was reflected in the higher discount rates which lower the present value of the cash flow. In stage 1, the present value of expected cash flow (CFs) is 160. 32 which is 54% lower than the stage 1 value in question 5. The percentage of decrease is lower than the total project values decrease, since most of the value in stage 1 was generate from early years cash flow. The country risk in the short run is lower than in the long run. Because in the long run there are more chances for uncertainty events to happened. In stage 2, the present value of CFs is 194. 81 and it is 51% lower than the project value in US which also less than the percentage decrease of the total project v alue. And this is due to the same reason as in stage 1. In stage 3, the value is $109. 837 which is 89% lower than the question 5s value. The significant decreasing value is due to the value of stage 3 is mainly from terminal value. Since there are higher country risk and more uncertainty in the long run, stage 3s long run cash flows ( accommodate terminal value) are heavily discounted which lead to low present value. Question8Dow should bid for PBB no matter the project is in US or Argentine, since the total project values and stage 1 values are both positive in these two countries. Because Dow is an American company, the shareholders care about the US returns. The Project cash flows and stage 1cash flows are discounted by the cost of capital in US and get positive present values, which mean the PPB will increase Dows shareholder wealth. To determining how much Dow should bid, the company should aware that there are some requirements made by the Argentina government.First, the gov ernment set the minimum accepted price is 150million U$, which is the lowest range for Dows bid. Second, the government requires the bidder to have a statement of net worth of at least 5 billion U$. While, Dow has two other competitors Copesul and Perez also want to bid PPB. However, Copesul only has net worth $929,538,000 and Perez has net worth $1,461,000,000. Even if Copesul and Perez combine to bid PPB, their total net worth around $2,391,000,000 will be smaller than the $5 billion requirement. Therefore, Dow should not been threatened by Copesul and Perezs bid, and they should not affect Dows biding strategy.Therefore, for the bidding price Value of the bid= Value of (stage 1+2+3)-cost of PBB- cost of Polisur The cost of stage 3 is already included in the value of stage 3. In question 3, we obtain the Value of (stage 1+2+3) equal to$464. 734 million. Since the Value of the bid0, then cost of (PBB+ Polisur) $464. 734million According to the government requirement, Dow could bid PBB for $150 million, then their higher range for Dows bid should be $ 314. 734 million ($464. 734million- $150 million). Table 1 Table 2 Table 3 Table 4 Table 5