Case Study Diamond Chemicals

[pic 1][pic 2]

[pic 3]

Table of Contents

Executive summary        

Statement of the problem        

Background        

Methodology        

Results        

Conclusion and recommendations        

Recommendations        

Conclusion        

BIbliography        

Appendix        

Executive summary

Placeholder

Statement of the problem

  Placeholder

Background

Placeholder

Methodology

We decided to investigate the concerns about Greystock’s DCF analysis raised by the different departments and concerns highlighted in the suggested questions for the case, in order to assess the impact of these concerns and overall appeal of the project by identifying the relevant cash flows.

Identification of Key Problems and its resolution (Answer to Q1):

Upon investigation of the DCF analysis prepared by Frank Greystock, we suggest several changes that will enable a more accurate assessment of the attractiveness of the Merseyside project. These changes have been implemented in the Appendix.

• Inflation: A 10% initial rate proposed by Greystock is a nominal rate; the real rate is 7%, and the inflation rate is 3%. Therefore, we kept the discount rate at 10% for exact comparability to case exhibit and include a 3% inflation rate in cash flows.
• Corporate overhead expense: Corporate manual suggested that all new capital projects should reflect an annual pretax charge amounting to 3.5 percent of the value of the initial asset investment for the project to account for overhead expense. Therefore, we retained it in the DCF analysis with inflation.
• Sunk cost: We noticed the £0.5 million sunk cost for renovation efficiency was included in Greystock’s analysis. Since this money had already been spent over the prior nine months and therefore is a sunk cost, hence, we excluded this cost from our analysis.
• Exploitation of excess transportation capacity: DCF analysis needs to properly account for the acceleration of the rolling stock purchase (the £2 million cost) by two years by placing this capital expense in Year 3 (2003), then subsequently showing a related savings in Year 5 (2005) assuming that this cost of 2m is not additional but it is just accelerated shift in cost (part or whole) that anyway has to be borne by transport division in the year 2005 for growth purpose. Similarly, the change in the depreciation schedule of this asset needs to be reflected appropriately in the depreciation add-back after taxes.
• Cash flows of unrelated projects: The Assistant Plant Manager would like to expand the Merseyside’s production of EPC, and include the expansion with the current project proposal. The main project is for engineering efficiency, not expansion. Hence we excluded in our DCF analysis as it would be wrong to include the EPC expansion, as it should be considered as a different project by the directors.
• Cannibalization: The Sales and Marketing representative had additional concerns regarding sales cannibalization. Based on our analysis, we conclude that the analysis should not include consideration for the impact of cannibalization.  
• Lost Output: We believe that the formula to calculate “Lost Output—Construction” erroneously calculates this on the basis of the new output level. This lost output of 1.5 months should be based on the old output level, as the firm sacrifices a previous output capacity to implement the project.  
• Lost Sales: Greystock’s DCF analysis concluded that all customers would return within one year. A conservative approach would advocate that not all customers would return so quickly and this would impact sales, and should be included in the analysis.

Having identified the relevant cash flows, we recreated Greystock’s DCF analysis in Microsoft Excel, to reflect the above changes. As a final point, we recalculated the NPV, payback period, IRR, and average annual EPS (earnings per share), and compared them with the benchmark investment criteria.