DIAMOND CHEMICALS PLC (A):
The Merseyside Project
March 4th, 2015
Disclaimer: Due to the current worldwide economic slowdown, an oversupply of polypropylene in the industry, and thus a very competitive market, the valuation of the Merseyside project provided in the report may fluctuate in the case of alterations in selling prices, costs of production, or actual sales figures.
Diamond Chemicals is major competitor in the worldwide chemicals industry. It produces an extremely wide variety of polypropylene products and it has one facility in Merseyside and one in Rotterdam, Holland.
Key Points (Changes after the project) Recommendation
£9 to £9.25 million.
25.9% to 22.4%.
3.6 to 4.28 years.
£0.018 to £0.023
Based on our discounted cash flow analysis and scenario analysis that we prepared, Diamond Chemicals should accept the renovation of the polypropylene line. The project meets all the four investment criteria (if assumptions used are correct).
OVERVIEW OF THE MERSEYSIDE PROJECT
Diamond Chemicals should undertake the renovation of the compounding plant, refurbish the polymerization tank to achieve greater throughput, and relocate and modernize tank-car unloading areas, as the Merseyside project is very attractive. If undertaken, the project will have a net present value (NPV) of £9.25 million, an internal rate of return (IRR) of 22.4%, a payback period of 4.28 years, and an average annual addition to earnings per share (EPS) of £.023 (assuming all factors involved our valuation of the project are accurate) (figure a). Furthermore, the project will provide the polypropylene plant with energy savings of 1.25% of sales in years 1-5, and .75% in years 6-10. While evaluating the project we came across some discrepancies regarding the values used in the discounted-cash-flow summary produced by Frank Greystock. The previous evaluation of the project included a preliminary engineering cost of £500,000, which we did not include because we treated it as sunk cost. Although the purchase of new rolling stock costing £2 million was not included in the summary (Greystock disagreed that the cost of the tank cars should be included in the initial outlay), we reflected the charge for the use of rolling stock in our discounted cash flow (DCF) analysis because it is part of the project cost. Moreover, the discount rate of 10% used in Greystock’s analysis is not correct as the values in the analysis should be adjusted for price rises, thus, we used an inflation rate of 3% to compensate for this. The recommendation made by Griffin Tewitt, the assistant plant manager, of including the EPC project as part of the polypropylene should not be taken into account. Since the EPC project has a negative NPV, Diamond Chemicals should not undertake this project as the company would only push the bad project along the main plan, which has a positive NPV.
SALES AND GROSS MARGIN SENSITIVITY ANALYSIS
Our discounted cash flow analysis assumes that we can sell all the added output (an additional 7%) that will be produced if Diamond Chemicals accepts the Merseyside project. But, since the company operates in an extremely competitive industry, future actual sales figures may differ from the forecasted values obtained in our DCF analysis. In order to sell the additional output the company might have to lower its selling prices. Hence, we have used different values at which a ton of polypropylene product could be sold in order to demonstrate that the project is still attractive given the different scenarios. If the company’s price per ton drops 2%, that is, from the estimated £541/ton to £530.18, the project would have a NPV of £6.94 million, an IRR of 19.6%, a payback period of 4.67 years, and an average annual EPS of £0.019 (figure b). If it drops to £513.95 (5% discount) it would have a NPV of £3.47 million, an IRR of 15.2%, a payback period of 5.42 years, and an average…