Diamond Chemicals

Diamond Chemicals PLC(A): The Merseyside Project

1. Identify the relevant cash flows; 1n particular, the treatment of:

a) Sunk costs

The sunk cost should not be a cost that should be borne by the project, it is a cost which will be anyway incurred by the company. The sunk cost or Preliminary Engineering Cost is estimated at 0.5 Million Dollars

 b) Cash flows obtained by cannibalizing another activity within the firm

According to the Director of Sales, the prospect of the project makes her believe there will be a shift in capacity from Rotterdam to Merseyside. She believes that the cannibalization of such a project will result to a loss in sales in Rotterdam and this would not be worth it. But there is no cannibalization.

c) Exploitation of excess transportation capacity

The transport Division estimates that the implementation of the project would require an increase in the allocation of tanks cars to Merseyside. This would incur a 2 million estimate for the new stock.

d) Corporate overhead allocations

The Corporate overhead allocations is estimated at 3.5%. Must not be kept.

e) Cash flows of unrelated projects

The cash flow for the unrelated project (EPC) need not be considered in our budget as it will only increase our budget instead of keep it minimal. This way there are more chances of getting it accepted by the council.

f) Inflation        

Inflation is an important factor to be considered. The inflation rate is regarded as 3% per year according to the Treasury Staff.

2. What changes, if any, should Lucy Morris ask Frank Greystock to make in his

Discounted Cash Flow (DCF) Analysis? Why?

The Discounted Cash Flow created by Frank Greystock requires the following changes to be implemented.

• The inflation rate of 3% must be added to the DCF as it is an important factor to be considered. It is inevitable.

3. What should Morris be prepared to say to the Transport Division, the Director of

Sales, her assistant plant manager, and the analyst from the Treasury Staff?

• Transport Division: The transportation budget incurred due to the project may not be the entire 2 million as stated by the department.
• Director of Sales:  The project is not necessarily canabilizing the Rotterdam plant

• Assistant Plant Manager: The reason the EPC did not get accepted is because it was financially too high –GBP 750,000.

4. How attractive is the Merseyside project? By what criteria?

The Merseyside Project is will increase the productivity by 7%.

The NPV or Net Present Value is positive.

5. Should Morris continue to promote the project for funding?

Morris should continue to promote the project for funding owing to the following reasons:

• Payback period and NPV is good.