Diamond Chemicals Plc

Diamond Chemicals Plc (A)

The Merseyside Project

Case Analysis

Executive Summary

This report provides analysis and evaluation of a capital budgeting project proposed to Senior Management in Diamond Chemicals. The project has been proposed to improve the product output of Diamond Chemicals’ Merseyside factory. However, problems such as capital expenditure, marketing cannibalization, discount rate, etc. have recently surfaced from different departments. Diamond Chemicals need to take all these factors into consideration and eventually decide whether or not they should carry out this project.

Methods of analysis includes identification of the relevant cash flows and evaluation of impact on Earnings per Share (EPS), payback period, Discounted cash flow (NPV analysis) and Internal Rate of Return (IRR), with respect to benchmark investment criteria for similar engineering-efficiency projects.

The results provide a comparatively better NPV, IRR, payback period, and average annual addition to EPS. Since all four investment criteria are satisfied, the project can be considered applicable and beneficial to Diamond Chemicals. However, in order to make a desirable impact, Diamond Chemicals will have to-

• Include the £2 million cost of tank car purchase as capital expenditure for the project

• Include the potential loss of business volume at Rotterdam (cannibalization)

• Include the 3% inflation rate in the analysis

• Exclude the annual pre-tax charge of 3.5% for overhead and

• Exclude the £0.5 million engineering sunk cost from the analysis

Based on our study, Morris’ concern that further tinkering might seriously weaken the attractiveness of the project, stands corrected. We would like to recommend Morris to incorporate our revisions to the base case DCF (Discounted Cash Flow) analysis. However, we would also like to remind him that our suggestion is based on the assumption that this is the only project under consideration. If there were more number of projects, subsequently our recommendations would change and Morris would have to conduct further analysis.

Statement of the problem

Diamond Chemicals was a major competitor to all chemicals industry worldwide and a leader in the producer of polypropylene. In an effort to renovate and rationalize the polypropylene production line at its Merseyside plant and thereby make up for deferred maintenance and to exploit opportunities to achieve increased production efficiency, Lucy Morris proposed a project which required a £9 million expenditure. Characterized as an engineering-efficiency