Diamond Chemicals PLC (A): The Merseyside Project Harvard Case Solution & Analysis

Meanwhile, the option of Rotterdam Project should not be considered because Diamond Chemicals is not in a property business and the option is more like a speculation tool for the speculation of land value after 15 years; therefore, the value of this option has been removed from the projected cash flows. In addition to this, if Merseyside project is selected then it will result in loss of Rotterdam’s existing sales for which the executive management believes that no consideration should be made to the projection cash flows from Merseyside project. However, lost sales of Rotterdam will only be a result of going for Merseyside project; therefore, for the evaluation purposes a notional charge for the lost sales of Rotterdam should be made to the cash flow projection of Merseyside project, which has been incorporated in the revised projections.

However, the cash flow projections for the projects have been discounted using the predetermined cost of capital of 10% in order to arrive at the net present values of each project. When projected cash flows of Merseyside projects is discounted at 10%, so it provides present value of £10.11 million. Whereas, Rotterdam project provides net present value of £7.34 million and these net present values provide the value that a project will add to shareholders’ wealth if the project is proceeded with.

Furthermore, Internal Rate of Returns (IRR) generated by both the projects has been calculated based on the projected cash flows and Merseyside project is expected to yield IRR of 27%, whereas, Rotterdam project will yield IRR of 15%. IRR provides the maximum return percentage that a project will provide. In other words, it provides the discount rate at which NPV of the project will fall to zero.

Additionally, the project’s payback period has been calculated using the discounted cash flows calculated using the revised cash flow projections for both the Merseyside and Rotterdam projects so that they can be compared using the decision criteria set by corporate policy where Merseyside project has payback period of 4.06 years, which means that the initial investment of £9 million and later investment of £2 million will be recovered during the first 4.06 years of the project life. On the other hand, Rotterdam project has payback period of 8.46 years.

Meanwhile, the effect of each project in the earnings per share has also been calculated using the after tax net profits generated by each project where Merseyside project will result in annual average increase in earnings per share of £0.02 and Rotterdam project is expected to generate annual average increase in earnings per share of £0.03.

Conclusion

The recommendations of Mr. Morris, who is the plant manager at the Merseyside sounds quiet feasible that cost around £9 million in this competitive environment followed by £2 million investment in purchase of tank cars and this project seems to be the best option. For the Merseyside project, the net present value of £10.11 million as compared to Rotterdam project’s net present value £6.57 million is more attractive because it will add more value to shareholders’ wealth. The Internal Rate of Return (IRR) for the Merseyside project will be 27% and for the Rotterdam project the Internal Rate of Return (IRR) will be 14% that is quiet low. In addition to this, payback period is 4.06 years for the Merseyside project and for the Rotterdam project it will take 8.59 years in order to realize the initial investment and addition in earnings per share for the Merseyside project will be around £0.02 per share and the same for Rotterdam project will be £0.03 per share.

In addition to this, the decision criteria set by the corporate policy is met by the Merseyside project in terms of NPV, IRR, payback period and addition in earnings per shares, meanwhile, Rotterdam project only meets one criterion, which is earnings growth of £0.018 per share. Therefore, after the critical analysis of the two projects, the Merseyside project is recommended although it costs more than the Rotterdam project but it sounds feasible from different financial aspects.................................

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