Team case analysis 1: Nucor (Case #5, 75 points)

In each of the team case analysis assignments, your team is asked to apply three complimentary types of analysis to the same case: cash flow (where a template will be provided), scenario analysis (i.e., changes within the model), and strategic analysis (i.e., considerations outside the model, such as competitor behavior). Your deliverable should be a memo of up to two pages (plus attachments, such as the Excel sheet you used for the analysis). This memo should have four sections: one for each type of analysis and one giving and explaining your judgment of what action the firm should take in light of these three analysis.

In this assignment, your team will advise Ken Iverson, Nucor CEO, on whether to adopt SMS’s CSP process. In your memo to him, please address the following issues.

1. Cash Flow Analysis

The key question for this section is “By its own investment criterion, should Nucor undertake this investment?”

Using the Excel spreadsheet provided as a template to calculate the cashflow Nucor could expect if it adopted SMS’s CSP process.

The relevant spreadsheet is labeled “CF analysis-thin slab”. Most of the critical data is already in the spreadsheet, drawn primarily from Exhibits 12A and 12B. Please adhere to the following assumptions and conventions:

  1. Don’t change any of the figures I have input.
  2. Use 4% as the growth rate for the price of steel, not the historical 6.84%
  3. Assume the entire $280 million construction cost is incurred in 1986
  4. Depreciate the factory equally over 10 years (1989-1998). The spreadsheet says 12 years, which includes the two years the factory is under construction (1987, 1988). I want you to start in 1989, when the plant comes on line, and assume it loses all value over the next 10 years.
  5. Note that in applying its investment criterion, Nucor ignored start-up expenses and working capital costs. Thus, in figuring the assets of the minimill in 1989 or later, those expenses need to be added to the asset base before calculating ROA.

Although it needn’t be in the memo, please determine whether more traditional investment criteria (DCF or IRR) would provide the same answer as Nucor’s own investment criterion of 25% return on assets at 5 years.

2. Scenario analysis

Your recommendation in Part 1 relies on a set of assumptions. Identify a change that might occur in one central assumption and calculate how your conclusions for Part 1 change given that assumption. Drawing on the case, explain why the new scenario is important and whether you consider it likely or not.

3. Strategic analysis

While SMS’s thin-slab technology would offer operating advantages, these are narrowed significantly by the need to price lower than integrated mills because of the perceived lower quality of mini-mill steel.

Nucor’s competitors include both modernized and unmodernized integrated mills. While estimates vary, let’s assume that 40% of integrated steel capacity was in modernized plants. Exhibit 12B shows that Nucor would have large cost advantage over unmodernized integrated mills ($225/ton versus $300/ton for Hot Rolled) if it adopted SMS’s technology. However, the cost advantage over modernized mills is much lower. In fact, Nucor might find it difficult to compete head-on with a modern integrated mill that decided to price very aggressively (perhaps even predatorily).

This leads to two questions for you to answer.

Use the two “CF analysis” Excel worksheets, determine if we should expect the integrated mills to modernize mills that are currently unmodernized. Why or why not? Assume they follow traditional investment criterion (IRR, DCF) rather than Nucor’s.

Given your answer to the previous question, how concerned should Nucor be about competing against modernized integrated mills when it opens its first thin-slab technology mill, if it does so?

Please observe the following assumptions and conventions.

  1. Don’t change any of the figures I have input.
  2. Use 4% as the growth rate for the price of steel, not the historical 6.84%
  3. Assume the entire construction cost of modernizing a mill is incurred in 1986
  4. Depreciate the modernization evenly over 25 years, starting when it comes online in 1987. Assume the unmodernized plant has already been fully depreciated.

4. Conclusion

In light of all of the analysis above, should Nucor adopt the CSP process? Why or why not?