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

Introduction

            The investors of Diamond Chemicals were pressurizing the company to improve the performance of the company. Therefore, in order to boost the profits as well as the performance of the company, Frank Greystock analyzed a project of capital investment at Merseyside works in England. The initial investment for this project was 9 million pounds and Frank Greystock had performed the DCF analysis for this project. However, no one seemed to be satisfied with the analysis of the project.

The purpose of this project was to create opportunities related to increased production efficiencies by exploiting the deferred maintenance by making up for it. Furthermore, it had also been proposed by him that this project is going to improve the production output of Diamond Chemicals Merseyside factory. However, different issues have been raised by the members of different departments such as issues related to discount rates, marketing cannibalization and capital expenditures. Therefore, it needs to be evaluated and decided that whether diamond chemicals should go ahead with this project or not after incorporating all the assumptions.

Problem Diagnosis

            This case provides us with a go or not to go decision situation and a decision needs to be made based upon the net present value, internal rate of return, the payback period and the average earnings per share for the Mersey side project. The objective of this case is to identify all the relevant cash flows associated with this project and address all the concerns of the people of all the departments of the company.

Overall, based on the fact that the output is going to increase by 7% and the gross margin of the company would also increase by 1% at a level of 12.5%. Based on this, the requirements for energy usage would also be low. However, there were many concerns that need to be addresses. First of all, the transport division would be making the allocation for this project out of excess capacity.

However, in order to do this new rolling stock will have to be purchased to fuel the growth. Furthermore, the director of sales argues that this industry is facing economic downturn and this would result in oversupply of the production and as a result the management will have to shift the capacity from the Rotterdam site to Merseyside. This is not a positive factor however, the marketing vice president believes that the demand would increase once the market revives.

Moreover, the assistant plant manager of the company suggests including the EPC project as part of the Merseyside project so that the negative net present value of EPC could be sustained. If this is not incorporated then the EPC project is going to exit in three years’ time. Lastly, the treasury staff believes that the hurdle rate for the calculation is a nominal inflation adjusted hurdle rate and the real discount rate to be used should be 7%.

Analysis

            The discounted cash flow calculations had been drafted by Morris and the calculations could be seen in exhibit 2 of the excel spreadsheet. However, the net present value calculations and all the other metric calculations does not seem to be correct because most of the concerns have not been addressed therefore, a new discounted cash flow analysis has been performed in the excel spreadsheet for the Merseyside project. The concerns of the transport division, the ICG sales and marketing department, assistant plant manager and the treasury staff dew other issues have been addressed as follows.

Addressing Concerns of Transport Division

            The transport division will have to increase its allocation of the tank cars for the Merseyside project. A new car will have to be purchased by the transport division two years earlier than the original year planned, which would be from 2003 to 2005. The purchase of the tank cars is accelerated therefore, the depreciation shift will also have to be calculated and it would be applied to an earlier date.

Therefore, the depreciation for these new cars has also been incorporated in the discounted cash flow analysis. This is also linked to a new project therefore, the cost of 2 million pound will be paid in 2003 and it would be recovered in 2005. The same would be done with the depreciation as depreciation is a non-cash expense.................

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