When considering the Merseyside project, senior-management wants a positive impact on earnings per share. The addition to earnings per share was £28,800 with an average addition of £2,000 per year2. Calculated with erosion, the addition to earnings per share was £18,800 with an average addition of £1,100 per year2. The payback period for the project was 3.10 years, when considering the erosion of Rotterdam, this would increase to 3.46 years2. The net present value of Merseyside is £15.61 million and when considering erosion, the net present value is £11.37 million2. The internal rate of return is 33%, with the erosion, it is 28.2%2. Based on these four criteria, Merseyside is a valid project to consider.

When considering the Rotterdam project, the effect on earnings per share was £6,000 with an average addition of £2,100 per year4. With the erosion of Merseyside, the earnings per share would be -£2,700 with an average addition of £1,200 per year4. The payback period of the Rotterdam project would be 13.68 years and with erosion, it would be 14.24 years4. The net present value is -£3.24 million and when considering erosion, it was -£6.61 million4. The internal rate of return is 8.04% and with erosion 5.91%4. The Rotterdam project does not meet the criteria due to a negative net present value.

After analyzing each project, we would recommend that Diamond Chemicals accept the Merseyside project and reject the Rotterdam project. The Merseyside project has a higher net present value, higher internal rate of return, a shorter payback period, and larger earnings per share. These projects are mutually exclusive and even if they were independent, we would still reject the Rotterdam project due to its negative net present value.

After conducting a sensitivity analysis for inflation, we reaffirmed our decision to accept the Merseyside project. Even if the inflation rate deviates 50% in either direction, Diamond Chemicals will still have a favorable net present value and internal rate of return. If the inflation deviated -50% making our inflation 1.5%, the net present value would be £12.02 million, the internal rate of return of 29.1%, payback period of 3.35 years, and an earnings per share of £23,0005. If the inflation deviated +50% making our inflation 4.5%, the net present value would be £19.7 million, internal rate of return of 36.9%, payback period of 2.89 years, and an earnings per share of £36,0005.

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If Diamond Chemicals chooses to accept the Merseyside project, value would be added to Merseyside in the amount of £15.61 million and £11.37 million as a whole to Diamond Chemicals after accounting for the erosion of Rotterdam.

Introduction: Diamond Chemicals was under pressure from investors to improve its financial performance because of both the worldwide economic slowdown and the accumulation of the firm’s common shares by a well-known corporate raider. They were considering two projects, one at Merseyside and one at Rotterdam, which would increase output by 7% at each facility. A companywide increase in polypropylene output of 14 percent made no sense, but a 7 percent increase would. This would make the two projects mutually exclusive. Bruner: Case Studies in Finance

Diamond Chemicals PLC: Diamond Chemicals is a leading producer of polypropylene and a major competitor in the worldwide chemicals industry. Polypropylene is a polymer used in a wide variety of products such as medical products, film, carpet, and automobile components. Diamond Chemicals currently purchases propylene from four refineries in England. Propylene is produced through the course of refining crude oil into gasoline. They use two main production facilities one in Merseyside, England and the other in Rotterdam, Holland. Diamond Chemicals is considering two mutually exclusive projects, each at the respective facility. Bruner: Case Studies in Finance

The purpose of the Merseyside project is to update our plant in ways that are going to save energy and improve the process flow by: • Relocating and modernizing tank-car unloading areas, which would enable the process flow to be streamlined. • Refurbishing the polymerization tank to achieve higher pressures and thus greater throughput. • Renovating the compounding plant to increase extrusion throughput and obtain energy savings. Bruner: Case Studies in Finance

The project would have an initial outlay of £9 million and will require the entire line to be shut down for 45 days. This project would lower energy requirements and have a 7% greater manufacturing throughput. Also, it is expected to improve its growth margin to 12.5%. Bruner: Case Studies in Finance

Concerns at Merseyside: There are also some concerns that have been brought to our attention from different divisions of Diamond Chemicals. They include:

Concerns of the Transport Division: Concerns coming from the Transport Division were those of the increased capacity that they would receive as a result of the Merseyside project. This project would increase the allocation of tank cars to Merseyside. To realize this expansion, the Transport Division would need to purchase a new rolling stock. This purchase would cost £2.0 million. As stated earlier, Greystock has left this portion out of his Discounted Cash Flow analysis, stating that each division must fend for itself. We agree with Greystock’s decision in keeping the divisions separate.

Concerns of the ICG Sales and Marketing Department: The ICG Sales and Marketing Department are concerned about the possibility of erosion. If the Merseyside project is accepted, its new net present value would be £15.612. Taking into account worst case scenario, the erosion effects on Rotterdam would lower net present value to £11.372. Conversely, if we would choose to accept the Rotterdam project, its net present value would be -£3.244. Taking into account worst case scenario, the erosion effects on Merseyside would lower net present value to -£6.614.

Concerns of the Assistant Plant Manager: Griffin Tewitt had proposed a renovation of the ethylene propylene copolymer (EPC) production line. EPC is a variety of synthetic rubber which is sold in bulk to European tire manufacturers. The initial outlay of the project would be £1 million and will improve cash flows by £25,000 ad infinitum. This project, however, produces a net present value of -£750,000. Because of the negative net present value, we chose not to implement this project. Bruner: Case Studies in Finance

Concerns of the Treasury Staff: The Treasury Staff brought up a concern of using a 7% target rate of return. They thought that with a 3% inflation rate, the 10% hurdle rate should be adjusted down to 7%. However, we found that the 10% hurdle rate was in nominal terms, which corresponded with our nominal cash flows. If we would have used the 7% rate, we would have overestimated the net present value.

Merseyside Investment Criteria: When considering the Merseyside project, senior-management wants a positive impact on earnings per share. The addition to earnings per share was £28,800 with an average addition of £2,000 per year2. Calculated with erosion, the addition to earnings per share was £18,800 with an average addition of £1,100 per year2. The payback period for the project was 3.10 years, when considering the erosion of Rotterdam, this would increase to 3.46 years2. The net present value of Merseyside is £15.61 million and when considering erosion, the net present value is £11.37 million2. The internal rate of return is 33%, with the erosion, it is 28.2%2. Based on these four criteria, Merseyside is a valid project to consider.

The purpose of the Rotterdam project is to convert the plant’s polymerization line from batch to continuous flow technology and to install sophisticated state of the art process controls throughout the polymerization and compounding operations. The heart of this new system would be an analog computer driven by advanced software written by a team of engineering professionals in a Japanese institute. Bruner: Case Studies in Finance

The initial outlay of the project would be £8 million and spread over 3 years. If we accept this project, Diamond Chemicals will need a continuous source of propylene gas. This proposal suggests obtaining this gas by pipeline which would cost £3.5 million. Also, a consultant forecast that the right-of-way of the pipeline would have a value of £35 million in the future. Bruner: Case Studies in Finance

Rotterdam Investment Criteria: When considering the Rotterdam project, the effect on earnings per share was £6,000 with an average addition of £2,100 per year4. With the erosion of Merseyside, the earnings per share would be -£2,700 with an average addition of £1,200 per year4. The payback period of the Rotterdam project would be 13.68 years and with erosion, it would be 14.24 years4. The net present value is -£3.24 million and when considering erosion, it was -£6.61 million4. The internal rate of return is 8.04% and with erosion 5.91%4. The Rotterdam project does not meet the criteria due to a negative net present value.

Decision: After analyzing each project, we would recommend that Diamond Chemicals accept the Merseyside project and reject the Rotterdam project. The Merseyside project has a higher net present value, higher internal rate of return, a shorter payback period, and larger earnings per share. These projects are mutually exclusive and even if they were independent, we would still reject the Rotterdam project due to its negative net present value.

After conducting a sensitivity analysis for inflation, we reaffirmed our decision to accept the Merseyside project. Even if the inflation rate deviates 50% in either direction, Diamond Chemicals will still have a favorable net present value and internal rate of return. If the inflation deviated -50% making our inflation 1.5%, the net present value would be £12.02 million, the internal rate of return of 29.1%, payback period of 3.35 years, and an earnings per share of £23,0005. If the inflation deviated +50% making our inflation 4.5%, the net present value would be £19.7 million, internal rate of return of 36.9%, payback period of 2.89 years, and an earnings per share of £36,0005.

If Diamond Chemicals chooses to accept the Merseyside project, value would be added to Merseyside in the amount of £15.61 million and £11.37 million as a whole to Diamond Chemicals after accounting for the erosion of Rotterdam.