Diamond Chemicals PLC (A) Essay Sample
Diamond Chemicals PLC (A) Essay Sample

Diamond Chemicals PLC (A) Essay Sample

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  • Pages: 5 (1145 words)
  • Published: August 25, 2018
  • Type: Case Study
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Diamond Chemicals is a well-known chemical manufacturer that operates mills in both Liverpool, England and Rotterdam, Holland. These mills were established in 1967 and currently have a total annual production capacity of 250 units.

The production cost of 000 metric dozens polypropene is compared to that of low-priced manufacturers. It is slightly higher at 1.09 per ton compared to competitors (see Exhibition 1). The decrease in EPS from 60 in 1999 to 30 in 2000, along with the global economic slowdown, prompted the accountant of works director of Merseyside (Liverpool), Frank Greystock, to propose an improvement project. The goal is to enhance efficiency in the works, increase output, and save energy.

Frank suggested spending 9 million to renovate and apologize for the polypropene production line at Merseyside works. This project is part of the engineering-efficiency category and aims to increase production by 17,500 tons. T


he following investment standards apply:

  1. The average annual addition to EPS is 0.018.
  2. The payback period is 3.6 years.
  3. The NPV is 9 million.
  4. The IRR is 25.9%.


Closing down Merseyside works will take 45 years, during which customers will have to buy from competitors because Rotterdam's works are nearly full. After improvement, output will increase by 7%, and the gross margin will rise from 11.5% to 12.5% with lower energy requirements. However, there are four major issues both within and outside of Merseyside works. Currently, the transportation division can handle the additional capacity, but doing so would require purchasing new rolling stock two years earlier (from 2005 to 2003) in order to support growth.

The manager of gross revenues states that the industry is experiencing a decline and it appears that there is an excess supply in

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the factories. This requires reallocating capacity from Rotterdam to Merseyside. This adjustment does not actually result in overall growth for the entire company. The vice president of marketing, however, is less skeptical and believes that the market will recover and require more products at that time. The assistant program director suggests incorporating additional EPC improvement projects (costing 1 million) to maintain a negative net present value (NPV) of the EPC project.

Otherwise, this EPC project may have to be abandoned in three years. The treasury staff believes this assumes a long-term inflation expectation of 3% per year.

Analysis and Recommendation: Morris created a Discount Cash Flow analysis for this project using the information provided above (see Exhibition 2); however, it may need to be adjusted based on the current external environment and internal factors.


Now, let's consider a new discount cash flow analysis for the Merseyside project taking into account the following factors.

The analysis below covers the four main issues mentioned above. In order to expedite the purchase of armored combat vehicle autos, the conveyance division must buy a new vehicle two years ahead of schedule, changing the planned date from 2005 to 2003. This requires adjusting the depreciation schedule accordingly.

So, in the DCF calculation, it is necessary to include two twelve-month depreciations. In other words, the total depreciation can be calculated by adding the new depreciation of works and the new depreciation of armored combat vehicle autos (from 2004), and subtracting the original depreciation of new armored combat vehicle autos (from 2006) (refer to line 19-21 of Exhibition 3). It is important to note that the armored combat vehicle auto should be purchased in 2003 instead

of 2005. When comparing the original financial statement (without this project), it is estimated that 2003 will incur a loss of over 2 million, while 2005 will see an increase of more than 2 million.

In 2003, our hard currency flow will decrease by 2 million lb due to purchasing. However, this purchase of 2 million lb will be added back to our hard currency flow in 2005 (as referenced in line 31 of Exhibition 3). This will have a negative impact on other operations, particularly the Rotterdam works. Currently, there is excess capacity in the plants and the industry is going through a downturn. Consequently, it is likely that the Merseyside undertaking will need to reallocate capacity from Rotterdam to Merseyside in order to accommodate the additional volume. Furthermore, as stated in Exhibition 3, there has been an increase in final product since 2002 (17).

500 dozen of Merseyside may be at risk if Rotterdam production ends. Therefore, the incremental net income demand will be reduced by the cessation of Rotterdam production. However, predicting the industry's future is challenging. It is possible that after some years, the industry may improve, which will benefit the company through increased production. This DCF analysis is based on a conservative assumption to determine the value of investing in this project.

The EPC project, which was initiated by the works director of Helper Works, should be considered as a distinct project in the capital budgeting for Merseyside. While the EPC production is part of the overall production at Merseyside works, the project we are discussing here specifically focuses on restoring and repairing the polypropene production line. These two projects are independent of

each other.

We understand the importance of this EPC project for the company, but we suggest a separate capital budgeting for approval. As stated by Gowan, "The Treasury staff believes that this indicates a long-term inflation forecast of 3 percent per year." To maintain the profit margin, it might be necessary for the company to enhance sales by 3 percent each year. It is widely acknowledged that in numerous instances, the cost of goods sold will also increase proportionally with inflation.

If the company maintains its original gross revenues, this will result in a worsened gross. To account for this in the DCF tabular array, we include a 3% increase for both before and after the Merseyside project. The key figures from the table are new gross revenues [line 4 of exhibit 3], old gross revenues [line 9 of exhibit 3], and overhead [line 23 of exhibit 3]. Additionally, there is a potential risk of the plant being closed for 45 years.

Despite operating at full capacity, Rotterdam works faced the challenge of losing clients to competitors. Greystock remains optimistic that this client loss is temporary. However, it is uncertain whether these clients will return, given the industry's downward trend and oversupply of products. Consequently, there is a chance that the company may lose some clients to rivals. On a positive note, this situation will eventually lead to lower costs for goods and energy savings in the future. By referring to exhibition 1, it becomes clear that newer works have lower production costs per ton.

Once the industry recovers in the future, the new projects will have a stronger competitive advantage with lower costs and higher-quality products.

Decision: From


We have recalculated the cash flow for the Merseyside project, taking into account the depreciation of transportation, cannibalization of other projects, and a 3% annual inflation rate. The results of key factors are as follows: Net present value = 5.22 million, Internal rate of return = 20.31%, Payback period = 4.51 years, Average annual addition to EPS = 0.020. Based on this information, the Merseyside project meets all four investment criteria and is worth investing in for Diamond Chemicals.

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