Diamond Chemicals PLC (B):
Merseyside and Rotterdam Projects
Diamond Chemical PLC
Diamond Chemical Outline
Overview Mutually Exclusive Diamond Chemical’s Investment Criteria Merseyside Project Rotterdam Project Analysis Decision
Diamond Chemical PLC
Mutually Exclusive
• Strategic-Analysis staff says optimum increase in polypropylene is 7%. Both projects are for a 7% increase. • 2 Different technologies, if Rotterdam is accepted, can not change implemented technology • Capital Budgeting • New & better technology in the future • Worldwide economic slowdown • Location of plants: England and Holland • Rotterdam right of way
Diamond Chemical PLC
Investment Criteria
Diamond Chemical evaluates projects based on 5 criteria 1. NPV computed at the appropriate cost of capital 2. IRR 3. Payback period 4. Growth in earnings per share 5. Strategic factors
Diamond Chemical PLC
Does the Merseyside Project meet the Investment Criteria?
1. 2. 3. 4. 5. NPV £ 9 million IRR 25.9% Payback 3.6 years Growth in EPS £ 0.018 Ability to upgrade technology, flexibility option
Diamond Chemical PLC
Does the Rotterdam Project meet the Investment Criteria?
1. 2. 3. 4. 5. NPV £11.57 million IRR 17.9% Payback 7 years Growth in EPS £ 0.179 Technology
Diamond Chemical PLC
Merseyside SWOT Analysis
Strengths •Receive positive cash flows immediately •Higher cash flows in the beginning •Relatively short payback period •Can wait to see if German technology will be better than Japanese technology
Diamond Chemical PLC
Merseyside SWOT Analysis
Weakness •Production process is old & not continuous at times •Higher labor costs
Diamond Chemical PLC
Merseyside SWOT Analysis
Opportunities •Modernization •Increased output/Lower costs •Higher market share •Increased competitiveness •Technology flexibility
Diamond Chemical PLC
Merseyside SWOT Analysis
Threats •45 day facility closure will cause customers to purchase from competitors •Will have to compete to regain lost market share •Obsolescence of technology
Diamond Chemical PLC
Rotterdam SWOT Analysis
Strengths Polymerization process becomes continuous Flexible payment schedule (over 4 yr pd) Japanese technology proven successful in Japan Propylene gas pipeline option – decreased need for railroad tank car transportation
Diamond Chemical PLC
Rotterdam SWOT Analysis
Weakness
Lack of flexibility option Committed to project If better technology is developed can not integrate it
Rotterdam SWOT Analysis
Opportunity
Land value Use of right of way Future sale of right of way
Rotterdam SWOT Analysis
Threat
German technology Loss of right of way Lost cash flows from not implementing the Japanese technology
Merseyside & Rotterdam Project Rankings
What accounts for the differences in rankings?
NPV IRR Payback Period Growth in Earnings per Share
Diamond Chemical PLC
Managerial Flexibility
Flexibility option Implement Japanese technology at Rotterdam Upgrade Merseyside plant & wait to either Japanese or German technology Effects on the economic attractiveness of the project
Diamond Chemical PLC
Comparison Overview
Basic comparison of the 2 projects
Diamond Chemical PLC
Key Assumptions
If Rotterdam project is undertaken, it will have an erosion effect on Merseyside Merseyside project has lower risk; therefore, it should have a lower cost of capital Inflation is accounted for in the calculations for both projects Overhead costs of 3.5% of investment will be incorporated in the cost of each project The added transportation cost of £2 million will be included in the Merseyside project Cash flow analysis of each project is on an incremental basis Project analysis assumptions not commented on were used directly from the internal company analysis
Elizabeth Eustace Presentation
The Rotterdam project Detailed 90 page analysis Right-of-way for continuous supply of propylene gas Strategic factors:
Cost and output improvements First major European producer to implement the new technology
Diamond Chemical PLC
Lucy Morris Presentation
The Merseyside project Enhancement of the existing facility Improving the production process
Diamond Chemical PLC
Comparative Analysis of 2 Presentations
Merseyside is simple and to the point Rotterdam proposal is long & in depth
Diamond Chemical PLC
Rotterdam Project Analysis
NPV of Rotterdam project overhauled because of property sale Year 15 recognizes a £ 40.39 property sale NPV of property sale is £ 15.70 NPV of Rotterdam after property sale is taken out is £ (4.13) Should not be included in the project NPV, can be sold without technology being implemented
Merseyside Project Analysis
£ 2 million transportation cost added into the initial cost of the project NPV of Merseyside project after transportation cost is £ 5.10 IRR is 13.0%
Merseyside Project Analysis
Project has a flexibility option to implement new technology Additional cost of £ 4.5 million required for the flexibility option £ Year 4 is the first year after the payback of the initial cost of the Merseyside project is paid back If the flexibility option is exercised at year 4, NPV is £ 18.95
Merseyside Project Analysis
The optimal year for the flexibility option is year 4 In comparison, if the flexibility option was £ exercised at the least appealing year, year 9, the NPV is £ 11.61
Merseyside Project Analysis
The flexibility option makes the Merseyside project more attractive
Improved NPV Improved IRR Improved growth in EPS
Merseyside vs. Rotterdam Project Analysis
Which project scores the best in regards to Diamond Chemical’s criteria?
1. 2. 3. 4. Merseyside w/Flexibility Option @ yr4, NPV= £ 18.95 Merseyside w/Flexibility Option @ yr4, IRR=17.6% Merseyside without Flexibility Option, Payback = 3.6 yrs Merseyside w/Flexibility Option @ yr4, Growth in EPS= £0.058
Recommendation
Which project to choose?
Diamond Chemical PLC
Select Merseyside Project with the exercise flex option in year 4