Diamond Chemical Plc. Harvard Case Solution & Analysis

Diamond Chemical Plc. Case Solution

Problem Identification

The problems identified in the given case are related to the capital budgeting techniques as applied by the company on the Merseyside Project, which requires an initial outlay of capital expenditure of GBP 9 million. The results of the techniques are not accurate because of the various concerns raised by different departments in the organization, including the transport division, assistant plant manager of the company, treasury staff and other parties. The issues as identified by these above mentioned divisions are summarized below:

  • No adjustment has been made for the inflation rate prevailing in the country.
  • Preliminary engineering cost and sunk cost that have been incurred before the project implementation.
  • Transport division concern over rolling stock.
  • Cannibalization, capacity shift from Rotterdam Plant
  • Ethylene-Propylene-Copolymer Rubber (EPC) cost has not been properly implemented.
  • Treasury Staff raised concerns for the wrong discount rate used in the DCF valuation.
  • Overhead Expenditure is not correctly utilized according to the company‚Äôs policy.
  • Lost Sales in the period of project implementation.

By incorporating all these issues in the case, the proper recommendation could be made for the given case. However, the recommendation could be made only by considering the assumption that the company is currently considering only one project at this time. In the case, if the company considers multiple cases into consideration, the recommendations could be changed significantly.

Analysis of the Capital Budgeting Techniques

It can be seen that the company is using four different capital budgeting techniques and on the basis of their results, the company proceed further on deciding that whether to undergo with the project or not. The first result derived from the quantitative analysis of the project is on the earnings per share of the company. Since the shareholders are the real owners of the company and they are forcing the managers to come up with the best alternatives so as to increase the financial health of the company in the given case, which strongly concludes the fact that the value of earnings per share should increase. For the proposed engineering-efficiency project, the value of the earnings per share should be positive, which in the given case is coming.

The second technique of capital budgeting process is the payback period. For the proposed engineering-efficiency project, the maximum limit for the payback period should be around six years whereas in the given case, the analysis made by Grey stock reveals payback period of 3.6 years, which is quite a favorable result.

The third technique used by the company of computing the net present value of the project is far more significant one as based only on this, the company can make some recommendations and is widely used and practiced by a number of companies as evident from the empirical studies. It can be seen from the current analysis, that a positive net present value is computed, which results favorably for undergoing with the project. However, in using the discounted free cash flow method for the computation of net present value, the company is not using a appropriate discount rate. Due to which, no recommendation could be made with this result.

The last method utilized by the company to evaluate the viability of the overall project is the internal rate of return. For a project like the one that company has started, the internal rate of return should be more than 10% whereas the analysis made in the case reveals an even higher internal rate of return of about 25.9%, which yields favorably.....................

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