Diamond Chemicals

Case Preview

Diamond Chemicals plc is a main competitor in the worldwide chemicals industry. The company positions itself as a supplier to customers in Europe and the Middle East. Frank Greystock proposed a Merseyside Project to expand £9 million to renovate and rationalize the polypropylene production line. The objective of this report is to demonstrate the capital added to this project by different divisions.

Capital-expenditure Proposals

Morris discovered Diamond Chemicals should not focus on just spending on the most essential part even though she just had limited capital expenditure. The company should also spend on those routine and deferrable. On the other hand, in order to improve the process flow and save energy, the company tried to redesign the outdated plant. The company wanted to relocate and modernize tank-car unloading areas, refurbish the polymerization tank and renovate the compounding plant. After doing these actions, the company would get greater throughput and obtain energy saving.

This proposal should be prepared in detail since this would affect the whole firm's cash flow. We made many assumptions so as to see if this proposal meets our aim. The firm proposed a £9 million expenditure on this program. She assumed the manufacturing throughput should be 7.0% greater than before. The Energy savings/Sales in Year1-5, Year 6-10 and Year 11-15 are 1.25%, 0.8% and 0.0% respectively. For the plant, we used 15 years as the depreciable life.

Diamond Chemicals evaluates its proposal based on four criteria:

Impact on earnings per share

Payback

Discounted cash flow

Internal rate of return

In order to seek approval from the board, an engineering-efficiency project should have positive contribution on EPS; the payback period should within six years; NPV should be positive; and IRR should greater than discounted rate.

To summarize Frank's proposal, the 1) Average annual addition to EPS is £0.018; 2) Payback period is 3.6 years; 3) NPV is £9.0 million; 4) IRR is 25.9%, which meets all criteria mentioned above.

Concerns on the Transport Division

The cost of purchasing new rolling stocks should not be included in the prediction of the project, because the Transport Division can make the allocation out of excess capacity. Although it needs to purchase new rolling stocks from 2003 to 2005, these rolling stocks are used to support growth of firms in other areas. The cost will still happen without the project.

However, the project accelerates the purchase, the loss of time value of the purchasing price should be allocated to this project.

We assume the transport division decided to make the purchase at 2003 instead of 2005, because the project occupied the capacities of it. A compensation of time value of £2 million should be included in the cost of the prediction of the project. This number would be 0.0347 million. (For example, discount rate is 10%)

2- 2/(1+10%)^2 =£0.0347 million

The sensitivity analysis (Table 1) shows the scenarios of accelerating the purchase by 1-12 years.

Concerns on the ICG Sales and Marketing Department

For ICG sales and marketing department, cannibalization, in definition, refers to a decrease in sales volume or revenue, or market share of one product because of the introduction of a new product by the same producer,