Project Risk and Cost Management
Diamond Chemicals PLC (A): The Merseyside Project
Group Members: Divya Yadav, Lamia Nafees, Ashwin Chadaga, Deeshanu Sharma
This summary report provides an analysis and estimation of capital budgeting proposed that is being proposed to the Senior Management in Diamond Chemicals. The goal of this project was to save energy, improve process flow and product outputs of the Diamond Chemical Merseyside factory.
Diamonds Chemicals, a major competitor in the worldwide chemical industry and a leader in the producer of polypropylene. Lucy Morris, the plant manager estimated £9 million ...view middle of the document...
The tax rate required in capital-expenditure analyses was 30 percent. Greystock exposed that any plant facilities to be replaced had been completely depreciated. He included in the first year of his forecast “preliminary engineering costs” of £500,000, which had been spent over the preceding nine months on efficiency and design studies of the renovation. Moreover, the corporate overhead allocation is at the rate of 3.5%. Greystock had decided to modify the DCF and suggested that the capital program requires 10% hurdle return rate for the project.
There were some concerns imposed by the transport division, ICG sales and marketing department, assistant plant manager and the treasury staff at Diamond Chemicals to carry out this project. Firstly, the transport division responses were that the company will be needing more propylene gas to be transported, without this the raw material cannot be completed. For this consideration, the transportation division will have to increase its allocation of cars to Merseyside and the controller at Diamond Chemicals has refused to add this cost into the project. Secondly, the ICG department were concerned about the market polypropylene which is very competitive. They assumed that the industry is in a downturn and it looks like an oversupply is in the works. The VP of marketing is skeptical about the sales figures due to the ongoing downturn. He said that with lower costs at Merseyside, Diamond Chemicals might be able to take business from the plants of competitors such as Saône-Poulet or Vaysol. Thirdly, Griffin Tewitt, the assistant plant manager had proposed a renovation of the EPC production line for a cost of £1 million. It is understood that renovation would give Diamond the lowest EPC cost base in the world and improve cash flows by £25,000. And lastly, the treasury analyst says that the discount rate used is improper and the target rate of return for Diamond Chemical should be 7 percent.
To sum up, Morris reviewed Greystock’s analysis and settled the questions surrounding the tank cars and potential loss of business volume at Rotterdam. Merseyside project met the four criteria, average annual addition to EPS = £0.018, payback period =3.6 years, net present value = £9.0 million, internal rate of return = 25.9 percent. Based on our study, we recommend to undertake the project due to several reasons such as it meets all investment criteria and adds significance to shareholder and the NPV is less than 0.
The results based on the case study demonstrates a better NPV, IRR, payback period and annual EPS. We recommend to proceed with the project as it will be beneficial for Diamond Chemicals. Here are some proposals for Diamond Chemicals to consider;
• Take into account the cannibalization charge
• Take into account the 3% inflation rate in the project
• Disregard the £500,000, engineering sunk cost from the study
Statement of the Problem
To determine if the proposed project by the...