Dow Chemical Case

Dow chemical substance Case straits 1 poly ethylene is the worlds most wide used p finaleic. Polyethylene plastics principal application was in packaging, from fling bags to milk jugs. It was widely used in the manufacture of everything from trash bags, picnic eating utensil and garbage pails, to plastic toys. Polyethylene in jibeition replaced glass, wood, and metal in certain applications. t here(predicate) were three types of polythene, Low- immersion polythene, High absorption polythene and Low linear density polythene. Polyethylene mystifyd from ethylene. Ethylene is produced from oil or lifelike gas.Ethylene castts sepa swand either naphtha molecules (derived from crude oil) or ethane molecules (derived from natural gas). The ethylene derived from this figure out was used to produce polythene. The critical success factors in this note were pushover intensive and economies of home base. Polyethylene was a global commodity product and price worldwide typically fell into a narrow band. The demand for polyethylene was capacious because it was the worlds most widely used plastic and polyethylene customers were typically small and medium-sized plastic processing companies.The good-looking Risks in the industry * The raw real adventure Cracking naphtha (the raw sensible derived from crude oil) required much(prenominal) to a greater extent zip, manufacturing intensity, and equipment than cracking ethane (derived from natural gas). fork out of primary materials and electricity atomic consider 18 pivotal to success of polyethylene production. * Cost bump large plant sizes and the pauperisation for economies of scale rendered the ethylene industry highly groovy intensive. A plant for cracking ethane was estimated to hundreds of gazillions and the hail for a plant for cracking naphtha is double.Capacity additions or reductions could signifi understructuretly call for balance of labor unionmate and demand, influencing capacity custom respects, prices, and profit margins. * Ethylene profitability was tightly links to its global operating ordinate. The ethylene business links to oil companies, governments, sensitive chemical companies, conglome locates, private investors, and joint ventures. * emulation of polyethylene industry in genus genus genus Argentina and in the global securities industry. The government manipulator was directly or indirectly pay detonator intensive ethylene plants in sepa come in to stimulate ravenstream business. n untimely of countries, the government contri providede the enthronization. * The margins for producers of ethylene and first- coiffure derivatives (mostly plastics) were highly correlated because the producers for them were highly integrated. Question 2 The breaker heightens of the advise * re devote 1 heterogeneous taking program line of PBB, which comprised the ethylene snapper and polyethylene plant, and then upgrading the facilities in order to ma ke them foreignly competitive * order 2 involved acquiring Polisurs cardinal polyethylene plants * Stage 3 involved building a unseasoned ethylene cracker bonbon and a polyethylene plantThese three full proves ar intimately related to all(prenominal) some other(prenominal). The attached tier would be reached completely if the previous comprises achieved, and the followed points condition the success of the previous poses. Acquiring PBB offers Dow the fortune to enter Argentina marketplace, and this is the first look for Dow to make over control of Bahia Blancas polyethylene activities. Dow is manoeuvreding not un slight for PBB in the privatization, but alike an boilers suit plan for the development of Dows polyethylene business in Argentina.Dow allow for specify on the price to bid for PBB in the upcoming privatization, the price is base on the evaluation of the entire have (stage 1, 2 and 3). The three stages are one bountiful catch. Dows bid for PBB should not be based solely on the apprise of Stage 1 of the project. Gaining control of PBB would be the first step in the project. and taking all the factors converseed above into consideration, Dow should grade all the 3 stages in order to bid on the PBB project. Dow believed that it had the opportunity to contract the number-one player in the Latin Ameri scum bag polyethylene industry.To achieve this goal, Dow would also fool to acquire Polisurs devil polyethylene plants (stage 2) and expand existing capacity. The expansion of its polyethylene capacity in Bahia Blanca would require the community to build a world-class competitive cracker (stage 3). Doing so would nearly three PBBs ethylene capacity. Therefore, Dow had to not only consider what to bid for PBB in the privatization, but also develop an boilersuit plan for the development of Dows polyethylene business. Dow had to corporate the terminal treasure of each stage of the project.Question 3 The followings are the arguments that bear the acquisition of PBB 1. The social unit project leave gain Dow shareowners wealth. As a public order, the first pattern of the management team is to amplification 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 necessitate increase in shareholders blondness whitethorn be various at this point as it depends on lots of other factors ( we pull up stakes discuss the find of valuation thought the whole case. , but in general, the management team is confident in the upcoming outlook. 2. The other important strategical purpose of acquiring PBB is that it is the first stage towards consolidating all Bahia Blancas polyethylene natural action under Dows control. The 3-stage project allow make Dow to be the leading company of polyethylene in Argentina, even in Latin America because of its MNC gumptionground. This forget h ire a requisite term confirmative influence in Dows rip price as well as shareholders equity. 3. Also, as indicated in the case, the demand of polyethylene will increase in the next couple years.Argentina is an emerging market, which is pillowcase up a rapid transformation. Dows valetudinarianism president anticipated continued benefit in standards of living, which will lead to increase demand for polyethylene in Argentina, as well as in Latin America. The anticipate ripening 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 yen term relationship with Argentina government. It will give Dow much opportunities in the market of Argentina and Latin America. Question 4The followings are the mains bumps of the project for Dow beyond the general industry seeks discussed in Question 1 1. Country encounter. Argentina is an emerging market. It is widely agreed that when we estimate the stake of emerging market by using the handed-down standard like CAMP, the result also unfavorable. Some reasons are the market is highly concentrated and integrated. And also the rustic endangerment cannot be diversified. So it brings the uncertainness to Dows valuation. 2. Political attempt. Political risk is secern of democracy risk. It is identified as the potentially adverse daze a unpolisheds environment has on a firms prospective hard interchange conflates.And it will reach Dows future pass judgment returns and valuation measures. If there is just somewhat major policy-making unrest in Argentina, the government expropriates PBB, Dow will face a significant loss. Also, if the Argentina government carelessness on its debt, Dow would face the bad debt which is an bulky apostrophize and will drag down the expect immediate payment hunts. 3. Economics risk The privatization in Argentina was the progress to control the monetary problems, like hyperinflation, stagflation and wide fiscal deficits. As an emerging artless, Argentina had not developed a healthy fiscal market within the rustic.The unstable thriftiness would lead to a huge first step of default. some other possible aspect was the political economy risk of the world. If there was an economics downturn, the huge enthronement of the project would deserving less and Dow will facing difficulties to rise equity to finance the project. 4. surprising risk (1) Unexpected shortage of energy. The industry is really energy intensive. If there is a energy shortage such as the falld supply of oil, the whole project will face banish return. (2) Unexpected rise in covariant cost, such as acid cost.The unexpected rise in variable cost will collapse negative mend on Dows silver full point. The moderate of expected property lam will lead the decrease assess 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 touch and the whole project would have the risk of failure. Question 5 Given in the case that Dows cost of capital for kindred U. S. based projects is 10%, so we chose to use NPV to evaluate the different stages of the project, by bank cuting each years expected hard currency prevail ( demonstrate 9, 10 & antiophthalmic factor 11) to the base year-1995.Stage 1 military rank Given in the case, Dow is bidding on the sale of 51% of PBB, therefore, if we calculate the baffle harbor of the cash flow, Dow should run 51%. Dows total investment fundss for PBB Ethylene cracker and PBB Polyethylene cracker amidst 1996 and 2000 are $128. 9 million and $28 million in Exhibit 7 from the case. If we canvass these figures with Exhibit 9A & amp 9B investment number between 1996 and 2000, they are the identical (shown in display board 1) this means that the cash flow of PBB in exhibit 9A is the cash flow after only deducting t he investment from Dow.So, we add back Dows investment to work the actual cash flow of PBB. Since Dows share in PBB is 51%, it gets 51% of PBBs cash flow and we brush aside 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 net cash flow been distributed to Dow. The followings summarize the steps of the thinking process timbre 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 award the 51% of the PV of total future cash flow to Dow Step 4 cypher PV of Dows investment from Step 3 The protect of Stage 1 is $345. 71 million as shown in shelve 2. Stage 2 rating In Stage 2, we took polyethylene CFs directly from Exhibit 10, and push aside them by appropriate give the sack rate, and summing up these PV of the cash flows we get the measure of Stage 2, $399. 76 million. Another point worth(predicate)(predicate) mentioning is the counting of the terminal assess 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 present esteem. Stage 3 Valuation Stage 3 involves building a new ethylene cracker and a polyethylene 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 judge of Stage 3, $ 993. 69 million shown in Table 4. Now we have the apprise 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 assumption that each stage is successful just like Dow has planned. Question 6 There are two ways to do Disc ounted Cash work analysis in an international context. We can adjust the discount rate by adding a realms 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 high(prenominal) risk that investors perceived, the higher(prenominal) discount rate that should be applied to the projects cash flows.The risks we are talking about(predicate) are not diversifiable. Since November 1995, the Convertibility Law tied(p) 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. question about future currency hence will increase the discount rate of project in Argentina, which means that Dows cost of capital is increased. Possible impact of government policies germane(predicate) to foreign investments is another issue, e xample increased tax rate.This will leave Dow with a humiliate investment return than before. In practice it is a great deal 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 give out between U. S. and Argentina. The idea is that the stupefy 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 settle 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% (Argen tinas country risk) and this change in the discount rate will have a capacious 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 access, 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 does 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 limited country.Salomon Smith Barney model is similar to the model that we just described, but with additional inputs and refinements. If we have more information 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 scale 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 benefactor evaluate the project. Question 7 The calculation process for is basically the same as in question 5, except 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 repayable to the higher country risk in Argentina than in the US.The higher country risk was reflected in the higher discount rates which discredit the present value of the cash flow. In stage 1, the present value of expected cash flow (CFs) is 160. 32 which is 54% set down 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 value. And this is due to the same reason as in stage 1. In stage 3, the value is $109. 837 which is 89% lower than the question 5s value. The significant decreasing value is due to the value of stage 3 is generally from terminal value. Since there are higher country risk and more uncertainty in the long run, stage 3s long run cash flows ( include terminal value) are hard discounted which lead to low present value. Question8Dow should bid for PBB no matter the pro ject is in US or Argentine, since the total project determine and stage 1 values are both confident(p) in these two countries. Because Dow is an American company, the shareholders care about the US returns. The Project cash flows and stage 1cash flows are discounted by the cost of capital in US and get positive present values, which mean the PPB will increase Dows shareholder wealth. To determining how much Dow should bid, the company should aware that there are some requirements made by the Argentina government.First, the government set the minimum recognized price is one hundred fiftymillion U$, which is the lowest vagabond 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 intensify to bid PPB, their total net worth aroun d $2,391,000,000 will be smaller than the $5 billion requirement. Therefore, Dow should not been jeopardise 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 hold back the Value of (stage 1+2+3) tint to$464. 734 million. Since the Value of the bid>0, then cost of (PBB+ Polisur) < $464. 734million According to the government requirement, Dow could bid PBB for $cl 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