Diamond Chemicals

Executive Summary

Diamond Chemicals PLC’s Merseyside is under pressure due to dropdown in its share earnings from £60 in 1999 to £30 in 2000. The propylene production line is old at the Liverpool Plant and it needs maintenance and renovation. The Merseyside renovation Project will propel Diamond Chemicals into the future by ensuring competitive production at competitive pricing while ensuring a stable gross profit for years to come. To account for concerns raised by various divisions such as accelerating the rolling stock purchase, adjustments in inflation and discount rates, indirect costs, and expansion effects, the following changes are recommended over Grey stock’s initial analysis:

o To consider estimations based on present value, no inflation is considered and real target rate of return i.e., 7% is considered for analysis.

o To guarantee a buy-in from Transport Division an additional investment of £2M is made towards purchase of rolling stock while ICG receives depreciation benefits of investment.

o Opportunity loss and loss of customers due to shutdown is considered for analysis

o WIP Inventory cost is considered until the plant reaches maximum production capacity.

o Sunk costs, preliminary engineering costs, are not included in analysis.

o Analysis assumes that low costs gained due to efficiency would steal business from competitors and not cannibalize Rotterdam sales.

o EPC project would not be considered as the success rate of renovation is not guaranteed.

The project is expected to have an NPV of £9.4M with payback period of 5.79 years would have a significant annual rise in EPS of £0.015. It also meets all evaluation criteria for an engineering-efficiency project with a guaranteed positive result. Hence the project should be taken forward for an approval from stakeholders.

Merseyside Project Problem Statement

The objective of the case study is to evaluate the current Discounted Cash Flow(DCF) analysis of the Merseyside project by Greystock and assess the overall appeal of the project. The current DCF analysis raised some issues which need to be addressed such as whether to consider inflation factor of 3%, indirect transportation costs worth GBP2 million, or include the EPC projects for strategic advantages and cannibalization of the Rotterdam plant from the increased production line at Merseyside site.

Background

Diamond Chemical is a major competitor in worldwide chemicals industry and a leading producer of polypropylene. It produced polypropylene at Merseyside and in Rotterdam, Holland. Since the Merseyside plant production is old, and inefficient, it needs renovation to achieve production efficiency. The Merseyside Project at diamond chemical was born out of a concern from economic slowdown, massive decline in Earnings per share by 50% (from GBP60 in 1999 to GBP30 in 2000) and deferred maintenance that calls for a need to improve efficiency of the production line to obtain an edge in the competitive market. Therefore, investment and renovation of the production line at Merseyside is imminent. James Fawn, executive vice president and manager of the Intermediate Chemicals Group (ICG) of Diamond Chemicals is the stakeholder to whom the proposal would be presented by Morris and Greystock together.

Methodology

Investment Outlay: Initial investment for ICG project is £9M. But the concerns raised by Transport Division, seems valid. Since ICG’s efficiency project would accelerate the purchase of tank cars by 2 years, in the best regards of ICG to get a buy-in from Transport division, it is appropriate to allocate £2M funds to transport division for the purchase of rolling-stock. And ICG can enjoy the benefits of depreciation with a DDB depreciation for first 8 years and straight-line depreciation for last 2 years. Hence would be a win-win situation.

Inflation Rate: To make an estimate of costs based on today’s value, zero-inflation is considered. Hence, the Discount Rate has to be adjusted to Diamond’s real target rate of return, i.e., 7% as suggested by Treasury Staff should be considered.

Opportunity Loss: The analysis should account for two types of opportunity costs

o Loss due to construction: This loss should be accounted in the analysis based on the previous/old output value (250,000 metric tons) for 45 days shutdown.

o Loss of customers: Assuming customers would return in the first year is a hard-stop. Hence to avoid overestimating the project potential, 5% loss of customers (revival of 1% of customers every year) is considered. It is also important to ensure and assume that marketing team would bring in rigorous strategies to revive lost customers