Edit this essay
only $12.90/page

Victoria Chemicals PLC: The Merseyside Project Essay Sample

Victoria Chemicals PLC: The Merseyside Project Pages
Pages: Word count: Rewriting Possibility: % ()

Executive Summary
The purpose of this report is to provide an understanding and analysis regarding the project proposed. The report starts with a brief overview of the company and the project proposal. This report then continues with assessing the concerns of Transport Division, ICG Sales and Marketing Department, and Treasury Staff. Furthermore, this proposal will also evaluate the recommendation from the Assistant Plant Manager. Then, the proposed analysis is compared to the Greystock’s analysis. The NPV and the IRR of the proposed analysis are lower than the Greystock’s. Nonetheless, both analysis state that the project is attractive to the company. There are some changes that need to be done in the Greystock’s analysis. The proposed analysis satisfies all the performance ‘hurdles’. Finally, there is a recommendation included for the management to discuss.

Company Overview
Victoria Chemicals PLC is a producer of polypropylene, a chemical commodity. A corporate raider has accumulated the company’s common shares. Thus, the earnings had fallen by 38.8% from 250 pence per share to 180 pence per share at the end of 2007. The proposed expenditure of GBP 12 million is hoped to improve the company’s financial performance and add values to the shareholders.

Proposal evaluation (Greystock analysis)
The Merseyside Project (MP) is a modernization program for the Merseyside Plant, one of two of Victoria Chemicals’ (VC) plants. MP can be said as a conventional cash flow project with an initial cost outlay of GBP 12 million and positive cash inflows for the next 15 years (2008-2022). Evaluation of a capital expenditure includes discounting or non-discounting methods. Victoria Chemicals (VC) uses the discounting methods, which are net present value (NPV), and internal rate of return (IRR). The discount rate used for the NPV evaluation is a nominal rate of 10%. For the hurdle rate in the IRR evaluation, 10% is also used.

Proposed analysis: Relevant cash flows and changes in Greystock analysis1 Firstly, in the cash flow analysis, it is important that only incremental cash flows are included in the calculation. A GBP 500,000 spent on preliminary engineering expenses should not be included because it has already been incurred and irrelevant to decision making.

Moreover, as the cash flows that are used in the calculations are real cash flow, it is must be discounted by the real cash flow as well. The 10% hurdle rate is a nominal target rate of return; it should be changed to real rate of return. The hurdle rate that should have been used is the real (zero-inflation) rate, which is 7%.2 The Treasury Staff is correct about his findings.

Regarding the concerns of the Transport Division, the rolling stock purchase of GBP 2 million in 2010 should be calculated into the project evaluation. Even though this is an extra capacity, it has small impact to the project, therefore, this is deemed to be relevant to the project. The calculation must include an assumption about the usage of the rolling stock that is directly associated to the project’s throughput and only allocate that amount of cash outflow. This report uses an assumption of 5% allocation3 of cost to the project. Moreover, Transport Division is a support division in the company and as a separate division, the management has an incentive to use the excess capacity and enjoy the benefit of the implementation of MP. If the project goes well, the Transport Division managers may enjoy the bonus. There is a conflict between managements about cost allocation that will affect the implementation of MP.

Moreover, VC owns two plants, the Merseyside and Rotterdam. The implementation of the project will cannibalize the Rotterdam plant. If this is truly the case, then there has to be an opportunity cost included in the cash flow analysis. Contrary to Greystock, cannibalization is an opportunity cost due to the forgone revenue from the cannibalized plant. However, if the MP turns out to be able to take business from competitors, then the positive cash flow should be included in the analysis. However, this report will assume the worst-case scenario4.

Additionally, the close down period assumption of 45 days seems to be too short. This is a question that should be raised to the management on how did they arrive to that number. A project that is this massive might need construction time of 6 months, at least. If the downtime period is longer, then the output loss would be greater.

Finally, the new NPV calculation is GBP 0.39 million with IRR of 7.4%. the previous calculation by Greystock is overstated. The project generates positive NPV and satisfies the cost of capital hurdle rate.

Ethylene-propylene-copolyme rubber (EPC) production line

Ideally, all projects should add value to shareholders. In this case, the EPC project already has a negative NPV, therefore, the inclusion of the project will not maximize shareholders’ value. Moreover, EPC is a relatively small product in the European chemical industry. Combined with its marginal profitability, EPC product line project has no clear advantage to the company. This also seems like a huge bet as the recession has not ended and this project is betting on the unclear economic recovery. Including the negative NPV project into MP is not acceptable. Tewitt’s statement about linking his bonus with the operation makes him exposed to conflict of interest.

Comparison with Greystock’s DCF analysis
In the Greystock’s analysis,the NPV is GBP 10.52 million with IRR 24.3%. With the hurdle rate of 10%, the project clearly satisfies the board. Moreover, the project’s contribution to net income is positive, GBP 0.022 per share. Under his analysis, the projects need 3.8 years of payback period.

However, in the proposed analysis, the hurdle rate is lower, 7%.

1. Impact on earnings per share5: positive contribution of GBP 0.016 per shares 2. Payback period6: the project needs 5.16 years to amortize the initial project outlay completely. The period is higher than the Greystock analysis because at Year 1, the project has not produce a positive cashflow. 3. Discounted Cash Flow: the present value of all the future cash flows that will be generated by the project is GBP 0.39 million. This is the amount of the project’s worth to the company. 4. IRR: the discount rate used when NPV is zero is 7.4%

In order to be submitted to the senior management, the project needs to be classified as one of four categories; new product or market, product or market extension, engineering efficiency, and safety or environment. The proposed analysis of MP is an efficiency-engineering project because its implementation would lower energy requirement and increase production by 7% and gross margin by 1%, The hurdles for the acceptance of the project are; positive contribution to earning per share, maximum payback period of 6 years, positive net present value, and IRR more than 7%. MP satisfies all the four performance hurdles. The project is believed to benefit the company and therefore it is advised to promote the project for funding. The implementation of MP is believed to increase value to shareholders by GBP 0.016 per shares and give positive contribution towards share price. The company might use its available cash to fund the project. If there is none, the company is advised to borrow money or issue more stocks.

Search For The related topics

  • cash
  • value
  • Olivia from Bla Bla Writing

    Hi there, would you like to get such a paper? How about receiving a customized one? Check it out https://goo.gl/3EfTOL

    Haven't found the Essay You Want?
    For Only $12.90/page