USEC INC.
Yeyi Wu, Die Chen, Qing Yu, Xuan Chen
UConn School of Business
OPIM 5668, Professor Craig Calvert
March 24, 2016
Executive Summary
The case study on USEC INC. gives a detailed description of changes and influence on the USEC INC. due to a massive capital-expenditure project known as the American Centrifuge Project (ACP).The analyst worked for Rivanna Capital (Rivanna), a long/short equity hedge fund assessed the value of ACP to see if it was a value-creating investment, thus indicating if the stock of USEC is worth to be hold in a long position.
By pursuing ACP, USEC will increase the scale of the company and dramatically improve its competitive position. In addition, USEC requires large amounts of electricity to operate and the cost is huge, pursuing ACP helps to reduce the amount of electricity required and thus reduce the cost. If USEC continued to use the current Paducah plant, the cost of electricity will be very high. So in order to asses if ACP is a value-creating investment, we compared the results of introducing ACP and the results of using the current Paducah plant.
Statement of the Problem
It follows that the enrichment process that USEC has at the plant of Pudacah is currently consuming large quantities of electricity. This is mainly because of its technology on the diffusion of gas. They have been able to manage this cost due to the existence of a long term contract that they have with the suppliers of power. The fact that their contract is expiring, has resulted in the increment of the gas diffusion process, which in turn would at the bottom line decrease. This increment in cost thus, resulted in USEC pursuing other alternative options. Mainly because they are looking to make an increase of the uranium enrichment profitability, they are in the hot pursuit of an expenditure capital project that is called the (ACP) American Centrifuge Project. The intent of ACP, is to not only make an improvement on the efficiency it has on the production of Uranium that is fissionable but to also produce it at a cost that is lower than before. Furthermore, this would make USEC target higher shares in the market and profits because it ACP would help it position itself as the low-cost producer, ultimately, aiding USEC achieve its goal of staying ahead of their competitors technologically speaking, since they will be more advanced.
Although pursuing ACP will bring a lot of benefits in many aspects, the initial cost of the project is still very high and there exists so many uncertainties about the project. Because pursuing ACP will affect so many things such as electricity cost, royalty, capacity, selling, general, and administrative expenses, and also as years go by we should consider inflation and depreciation. So the main problem is to use the data provided to estimate the American Centrifuge Project’s NPV to see if it is a value-creating investment. If the net present value is greater than 0, then it would imply that the USEC stock was undervalued, and Rivanna should take a long position. Conversely, if the net present value of ACP is less than 0, which means it is a value destroying investment, Rivanna should short the stock to take advantage of it being overvalued by the market.
Background
USEC Inc., which is United States Enrichment Corporation. It is a corporation that contracts with the United States Department of Energy to produce enriched uranium which use in nuclear power plants. In 1992, The Energy Policy Act created USEC to privatize uranium enrichment for civilian use. In July 28, 1998, the U.S government received almost three billion dollars for USEC through the initial public offering of USEC stock. USEC had gaseous diffusion plants at Piketon, Portsmouth in Ohio and consolidated operations in Paducah in Kentucky.
Methodology
We decided to estimate the net present value, so we need to assess the value of the initial investment, the net cash flow in period t and the required rate of return or hurdle rate according to the session2 covered in class. The calculation of the initial investment is easy; we can directly discount each year’s investment by inflation rate which is estimated to be 3%. And the required rate of return we use the dividend yield = 0.55/10.8 =5.09% to discount the cash flow. The most challenging part is to calculate each year’s net cash flow. Because there are too many numbers and uncertainty, and in order to make it simpler, we ignored some information. We firstly calculate the production, the price of SWU and the cost of Uranium which are increased by inflation rate. Then we need to delimitate other expenditures and costs such as Selling, general and administrative costs and fixed costs. Also we should consider the depreciation. By putting the data into the NPV calculation templates we use in the class, we can finally get the result of NPV.