DIAMOND CHEMICALS PLC (A): THE MERSEYSIDE PROJECT
HimanshuDubey $a%ya R Manu Pasa
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In-2u3-i2n: Morris was plant manager of Diamond Chemicals’ Merseyside Works in Liverpool, England. Her controller, rank !reystock, was disc"ssing a capital pro#ect that Morris wanted to propose to senior management. $he pro#ect consisted of a %&ritish po"nds' ()*million e+pendit"re to renovate and rationalie the polypropylene prod"ction line at the Merseyside plant in order to make "p for deferred maintenance and to e+ploit opport"nities to achieve increased prod"ction e-ciency. Diamond Chemicals was "nder press"re from investors to improve its nancial performance, Earnings per share had fallen to (/0.00 at the end of 1000 from aro"nd (20.00 at the end of 3))). Morris th"s 4elieved that the time was ripe to o4tain f"nding from corporate head5"arters for a moderniation program for the Merseyside Works6at least she had 4elieved so "ntil !reystock presented her with several 5"estions that had only recently s"rfaced.
Ini-ia+ DCF ana+ysis:4 Assum5-i2ns 7nn"al 8"tp"t %Metric $ons' 8"tp"t !ain:8riginal 8"tp"t =rice:ton %o"nds' ?n@ation Aate %prices and costs' !ross Margin %e+. Deprec.' 8ld !ross Margin $a+ Aate ?nvestment 8"tlay Energy Bavings:Bales
190000 ;< 9>3
r. 3*9 r. 2*30 r. 33* 39
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Obe3-i%e: $o eval"ate rank !reystock’s DC 7nalysis of the Merseyside pro#ect, impacts to related departments, and overall appeal of the pro#ect to the Diamond enterprise. $ho"gh the pro#ect shows a highly positive = and meets all the investments criteria, there are some iss"esG 3. $he prod"ction line wo"ld have to 4e sh"t down for >9 days d"ring which c"stomers wo"ld 4"y from competitors. &asically, there is an initial constr"ction downtime. 1. $he pro#ect wo"ld re5"ire the parent company’s $ransport Division to invest 1 mn po"nds which the controller ref"ses to add in her own pro#ect’s o"tlay. /. $he marketing department is sceptical a4o"t sales g"res d"e to the ongoing recession. $he marketing team is concerned a4o"t canni4aliation. Canni4aliation really isn’t a cash @ow there is no check written in this instance. 7nyway, if the company starts 4"rdening its cost*red"ction pro#ects with ctitio"s charges like this, the cost competitiveness won’t 4e maintained. >. $he assistant plant manager wants the controller to incl"de an E=C pro#ect as a part of the overall pro#ect. 9. 7 $reas"ry analyst says the disco"nt rate "sed is incorrect. 7dditionally, the treatment of engineering costs is incorrect. ϒ $he controller at Diamond Chemicals’ Merseyside Works wants a pro#ect consisting of a ) mn po"nds o"tlay to 4e passed that wo"ld achieve increased prod"ction capacity.
Res2+%in. -he issues:4 ?ss"e 3G $ho"gh this is tr"e, there is reason to 4elieve that the c"stomers will come 4ack d"e to the cost e-ciency of Diamond Chemicals as shown 4elowG
Diamond Chemicals’ cost competitiveness will only increase after the completion of the pro#ect and it will thrive in the highly competitive market. ?ss"e 1G $he $ransport Division’s concerns are also well*esta4lished and this o"tlay sho"ld 4e incl"ded in the total investment for the pro#ect, making it 33 mn po"nds. ?ss"e /G $he concerns of the marketing department are well*esta4lished and need to 4e addressed. D"e to the sh"tdown for >9 days, there wo"ld 4e c"stomer losses for some time as not all c"stomers will 4e 4ack soon and ad#"stment needs to 4e made for that. ? have acco"nted for this loss to 4e the same as the e+pense d"e to lost o"tp"t d"ring the >9 days. Aegarding sales, it wo"ld 4e the task of the marketing department to drive the sales. We can 4e optimistic on that front as the market will revive even tho"gh the recession may persist for long. ?ss"e >G $he plant manager wants the E=C pro#ect to 4e incl"ded 4eca"se of its potential strategic advantages. $his is a classic corporate malpractice wherein an "nrelated pro#ect is o4sc"red and p"shed along an attractive one. 7nyways, the plant manager’s views need to 4e taken with a pinch of salt considering that the E=C market has contracted in the past few years d"e to new s"4stit"tes. $he pro#ect, th"s, sho"ld not 4e "ndertaken. Aather, Merseyside Works sho"ld start planning on creating new opport"nities to prevent layoIs. ?ss"e 9G $he disco"nt rate c"rrently "sed in eval"ating the pro#ect is 30<. However, it’s the nominal rate 4"t the cash @ows are real. Hence, the disco"nt rate "sed sho"ld 4e ad#"sted for in@ation, which is /<. Hence, the new disco"nt rate "sed is ;<.
=reliminary engineering costs of 0.9 mn have 4een spend on the e-ciency and design st"dies of the renovation and are th"s a s"nk cost. Hence, these costs sho"ld not 4e incl"ded in the analysis.
Su..es-e 3han.es: 7ss"mptionsG 7nn"al 8"tp"t %Metric $ons' 8"tp"t !ain:8riginal 8"tp"t =rice:ton %o"nds' ?n@ation Aate %prices and costs' !ross Margin %e+. Deprec.' 8ld !ross Margin $a+ Aate ?nvestment 8"tlay Energy Bavings:Bales
190000 ;< 9>3
r. 3*9 r. 2*30 r. 33* 39
Disco"nt Aate Deprecia4le Life %in ears' 8verhead:?nvestment Balvage al"e Wip ?nventory:Cost of !oods Months Downtime, Constr"ction 7fter*ta+ Bcrap =roceeds =reliminary Engineering Costs Deprecia4le Life * $ank %in ears'
Yea Es-imae 27 In3em en-a+ 82ss P29-
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ew Bales %Millions '
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8ld 8"tp"t
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3 > > ; 3 ; 9 0 0 3 1. 9 0 < 3 F 0 F ) 2 F F
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Es-imae 27 In3em en-a+ De5e3 ia-i2n
ew Depreci ation
ew Depreci ation* $ank
8verhea d =relim.E ngineeri ng Costs
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30.0; 10.0) <
D"e to change in h"rdle rate, = has gone "p even tho"gh ?AA has red"ced.
C2n3+usi2n $he pro#ect sho"ld 4e "ndertaken d"e to the following reasonsG
?t meets all investment criteria and contri4"tes to the shareholder val"e. ?t is likely to introd"ce e-ciency and res"lt in the long r"n gain to the organiation. With the new technology the organiation is likely to 4enet from the ret"rns to scale as well.