Victoria Chemicals Plc Case Study

Victoria Chemicals is considering a £12million capital project that one of its Plant Managers and Plant Controllers suggested to modernize the firm and better absorb its high cost of goods sold. Victoria Chemicals has the highest cost of goods sold in its industry. This case warrants expert-level analysis to properly propose this project in consideration of the firm’s need to regain lost earnings per share (EPS) value.

Victoria Chemicals is a major competitor in its industry that was a lead producer of a high demand product called polypropylene. The firm’s Merseyside Works plant, located in Liverpool, England and built in 1967, operates via obsolete and labor-intensive practices. The firm also has a plant in Rotterdam, Holland of equal capacity to that of Merseyside. Its market region is Europe and the Middle East.

Erosion is the gradual redirection of funds from profitable segments or projects within a business to new projects and areas. Although managers almost always consider money flowing into new projects to be investments in long-term growth, the short-term effect is a slow erosion of cash flows. If Victoria Chemicals modernizes it will experience an immediate surge in Working Capital due to the firm’s shifting in operations (need for more work in process inventory for the success of the project). This is a Decision Cash flow. As sales grow, Victoria Chemicals will need more working capital to operate, thus this cash flow is relevant and included. Financing Costs are not included because the cost to raise capital does not affect the attractiveness of the project.  Tax, however, is relevant because affect the cost of the project.

The project will trigger no purchase of tank cars today, but is included in the analysis because the project affects the timing of the purchase (2 years/periods) and creates necessity for adjusting depreciation. The changes made to the NPV analysis begin with changes to inflation. This case considers the cost of inflation in the firm’s discount rate, but the inflation must be included in the cash flow. Manufacturing overhead is not an incremental cost in Victoria Chemicals’ case.

Depreciation Adjustment

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Although excess capacity needs to be bought earlier than expected, it is not an incremental cost. Engineering is a sunk cost and is therefore excluded from NPV. Cannibalization is at hand due to the other plant and that will have to be subtracted out, and all the sunk costs are subtracted out allowing a new combined NPV of 18.76 which makes this project to be a very attractive and feasible one!

EPS is not a good project criteria since it is based upon earnings which is not the same as cash flow; it is an accounting metric. Earnings can be adjusted and are subjective.  The measure also does not consider the time value of money.  Payback tracks when the project returns the money invested, but does not tell if the project adds value and it ignores the time value of money and later cash flows. The NPV is the best decision factor because it tells us how much value the project adds, including all cash flows and the time value of money. Sometimes marketing factors, lack of funds or other external reasons might change the decision, but in general it gets approved.