Diamond Chemicals: Merseyside and Rotterdam Projects

Group 5 Edi Suryanto Gressiadi Muslim M Fahmiansyah Rudianto Nugroho Wibowo Kristianto

MAGISTER OF BUSINESS ADMINISTRATION FACULTY OF ECONOMICS AND BUSINESS GADJAH MADA UNIVERSITY 2011

Diamond Chemicals: Merseyside and Rotterdam Projects

Diamond Chemicals failed to jump in on opportunities and enhance their production process. Merseyside is a factory built in 1967. Merseyside production process is the production process that are old. Revenue per share has fallen to 30 Euros at the end of 2000 from around 60 Euros at the end of 1999. . Plant manager at Liverpool and Rotterdam have been independently compiling spending proposals. Both factories are identical in size. for the way they produced chemicals was old. the new designs would save energy and improve the process flow. energy savings/sales for the first five years after the expenditure will be 1. being appointed to her post almost a year ago. and cost the plant far more than its competitors. Since its establishment in 1967.Diamond Chemicals is a leading producer of polypropylene. executive vice president of the Intermediate Chemicals Group (ICG) Diamond Chemicals and John Camperdown meets its financial analysis. England and in Rotterdam.8% in the next 5 years due to an increase in total sales. and plant design. Lucy Morris. Therefore. declining to 0. The solution was aimed at developing new methods for the production of polypropylene. the polymer used in a variety of products (ranging from medical products to packaging film. each of which will increase the output of polypropylene from their respective factories by 7 percent. obsolete. age. proposed a £9 million expenditure plan as a solution. carpet fibers. the Netherlands. James Fawn. Diamond Chemicals is producing polypropylene at Merseyside. The managers of the two mills member reporting to James Fawn. but half of that number still makes sense. According to Exhibit 2. to review two proposals for capital expenditures that are mutually exclusive. Therefore. the best semi-continuous. he can only finance one in order to obtain approval from the council. and therefore has a total workforce of more than the other plant competitors. executive vice president and manager of the Intermediate Chemicals Group (ICG) from Diamond Chemicals. the Fawn will not approve the plan.25%. Diamond Chemicals is under pressure from investors to improve the financial performance due to economic slowdown worldwide and also the accumulation of common stock of the company. and automotive components) and is known for its strength and elasticity. Moreover. The staff of Diamond Chemical analyses the strategy to see that the increased capacity of the company's output by 14 percent is not possible.

Merseyside project meets all four investment criteria: . The tax rate required in the analysis of capital expenditure is 30%.5% to 12. finally. Another opportunity comes from the factory to improve the old design in a way that will save energy and improve process flow. Diamond Chemicals has received tank cars Merseyside Propylene from four oil refineries in Britain. Besides the mentioned advantages of the project. assistant plant manager and direct reports from the Morris proposed the renovation of EPC production line at a cost of £ 1 million. increasing throughput by 7% and improving gross margin from 11.So energy savings/sales would increase by a decreasing rate. the real target rate of return of Diamond Chemical (with. next. Some of these opportunities come from the postponement of the maintenance operation for five years earlier. Because the project has increased. Merseyside produces 250.5%. transportation should improve the allocation of tank cars to Merseyside. however. refurbishing the polymerization tank to achieve higher pressures and thus greater throughput. mainly for economic reasons. renovating the compounding plant to increase extrusion throughput and obtain energy savings. Greystock decided to continue using the discount rate by 10 percent. the executive committee had rejected the project. In accordance with the analysis Greystock. Andrew Cowan assume long-term inflation rate expected is 3 percent per year. other more essential positives that can be drawn from the project are lowering energy requirement for production. Diamond Chemicals PLC (A): Project Merseyside Morris conducts a detailed review of operations and finds opportunities for significant improvements in the production of polypropylene. The three most important objectives behind the project were relocating and modernizing tank-car unloading areas which would enable the process flow to be streamlined. the average price of polypropylene is 541 Euros per ton for Diamond Chemicals product mix. Tewitt Griffin. because it is promoted in the latest issue of capital budgeting manuals Diamond Chemicals. zero inflation) is 7 percent. Thus.000 metric tons of polypropylene pellets a year. Diamond Chemicals is run by a team of highly qualified personnel that are experts in their respective fields. Currently.

the proposal mentions Eustace for expenditure of £ 8 million which is divided into three years to change the path of a collection of polymerization plant to flow polymerization technology and merging operations. In essence. Diamond Chemical has the option to buy the pipeline and right of track for £ 3. IRR = 25.5 million. which is assumed to decline from the same volume of Merseyside to benefit from the volume of Rotterdam.9 percent Diamond Chemical PLC (B): Plan Rotterdam Proposals from Elisabeth Eustace consists of 90 full-page documents with the detailed scheme or chart. Additional average annual EPS = 0. then the pipeline can be extended to reach Rotterdam factories and refineries on the other end.9 percent.1. Practically.6 million. Installation of a sophisticated new system cannot be implemented without gaining a continuous source of supply of propylene. The calculation for the worst scenario conditions. This Option will expire within six months.0 million 4. comments from engineers. Based on the analysis of Discounted-Cash-Flow (DCF) and indicated that the plan has a NPV of £ 14 million and IRR of 17. Consultants also predict that for 15 years the value of the right lane will be £ 35 million.018 pounds 2. If the plan of Rotterdam is not done. Handling the new systemdriven software designed by a team of technicians is the professor from an institution in Japan. A consultant told Eustace if the purchase rights to the track now and make the pipeline is estimated to cost £ 6 million. NPV = £ 9. He suggested that to obtain this gas by pipeline from a refinery along five miles. Fawn remind "strategic factors" that Eustace mean by a clear cost and increased output expected from the new system. Payback Period = 3. once the decision was made to install it will not be refunded. then the option right to the path is not used until the end. as well as from profits generated as the first European major manufacturers use new technology. strategic analysis. An option has been purchased several years earlier. .6 years 3. and financial plan. The complexity of the technology owned and levels through the mill of a system would be very expensive to be dismantled. NVP of £ 11.

. If the rumors are true. and this gives a different effect on the value of each plan. Why Merseyside and Rotterdam projects called mutually exclusive? 2. The project. When it is possible to apply the German technology in five years. Why Merseyside and Rotterdam projects called mutually exclusive? Mutually exclusive projects mean that the acceptance of one project eliminates the others from consideration. manager of the factory on Merseyside. Key Issues/problems 1. Fawn believes that the flexibility of technological change differ between plans Rotterdam and Merseyside. Lucy Morris. this flexibility affects the attractiveness of investment? 4. How do the two projects are compared based on investment criteria Diamond Chemicals? What may be taken into account to distinguish it in the rankings? 3. it means letting go off the Japanese investment in the system. This is due to the limitation in the polypropylene industry that is only able to accommodate an increase in output by 7%. The projects are called mutually exclusive because they have to choose one project on the grounds: a.1:1. Statement of a staff analysis of Diamond Chemicals strategy which states that the project with increased output by 14% does not make sense. Is it possible to calculate the value of managerial flexibility associated with the Merseyside project? How. Projects are said to be mutually exclusive when they cannot be undertaken simultaneously. which must be proposed by James Fawn to the CEO and BOD? Analysis 1.The designer team of German engineers from Glusingen University has tested all these processes and systems to surpass Japan in reducing costs and improving quality with a factor of 1. What is the difference in the way Elizabeth Eustace and Lucy Morris filed their respective projects? How do these style differences affect the decision? 5. the system will be available commercially within five years. chose to "wait and see" how the German technology develops.

d. Diamond Chemicals comparison of the investment criteria of the two projects from 5 factors: 1. it will require funds amounting to 9 million pounds. . This also affects capital budgeting because the location of two separate factories will lead to higher costs and each state has different policies therefore it must choose one project alone g. If they choose Merseyside projects. f. If the Rotterdam project is not implemented then the right of way will be lost and deadlines 6 months. How do the two projects are compared based on investment criteria Diamond Chemicals? What may be taken into account to distinguish it in the rankings? a. If the Rotterdam project is approved it is assumed that the implemented technology not to be changed since it will be very expensive to change the system. NPV can also be used to measure directly the value of a project for the owner of the shares. 2.5 million.b. e. Each project presented to the development of better technologies in the future where the project will have more flexibility options can be easier to choose an alternative technology that is applied. NPV is the expected present value of future cash flow. So there is the possibility of losses for the company. The location of the two separate projects is in the UK and the Netherlands. World economic situation is declining. this might impact the market share of both projects. In this case Elizabeth Eustace has already bought the pipeline right of way. while the Rotterdam project requires funding of only £ 8 million. Rotterdam’s project to change the system from the use of polypropylene supply tank on the train was replaced by using the pipeline including the purchase rights of way which cost £ 3. In addition there is a commitment from management that if a decision had been taken then it will not be changed c.

Payback does not capture the entire flow of cash flows of a project and therefore not a recommended method in the evaluation of a project. and therefore many companies use it as a measure of risk. 6 yrs 25. but it assumes that all cash flows can be reinvested at the IRR. 5.2.average common shares outstanding.018 £ 0. IRR is the discount rate that equates the present value of cash flow in and out in the future is expected. Earnings per share or EPS was obtained from the profit attributable to ordinary shareholders divided by the weighted .60 million (worst scenario) IRR PAYBACK PERIOD EPS Positive £ 0. though payback measures the liquidity of a project. Note. EPS or earnings per share is net profit level for each sheet of the company shares that can be achieved when running the operation. 3. 4. Merseyside and Rotterdam Comparison: Parameter Merseyside Project NPV Positive £ 8.89% 8.6 years 17. Strategic factors are other factors that provide value-added when the project is implemented.92% 3.029 > 10% Max.99 million £ 14.2 years Rotterdam Project . Payback Period is the number of years owned by the company to earn back the investment in the project. IRR measures the rate of return on a project.03 million (expected) £ 11.

Improvements in gas supply line of polypropylene that were using the railway facilities which must go through three refineries to provide gas for a single refinery. A ranking can be used in the determination of mutually exclusive projects. there are opportunities in the application of German technology in Rotterdam project through an analog process-control system that offers benefits in increased output and reduced cost compared with a ratio of 1. the IRR is greater than the discount rate that is 10%. This gives the assurance of continuous supply for the plant in Rotterdam. This is because the existence of Lucy Morris hopes that the technology from Germany will be the technology that is superior Japanese technology. This is because the project in Merseyside only makes improvements to facilities that already exist. Besides. Rotterdam: 1. Merseyside Strengths • Receive positive cash flows immediately • • Rotterdam Polymerization process becomes continuous Flexible payment schedule (over . among others: Based on the criteria established by Diamond Chemicals. Application of technology from Japan that has been proven over 3 years to provide increased output and reduced costs and save energy. Supply through pipe line project includes the right of way for £ 3. it is the price when the sale has reached £ 6 million. 2. among others: the NPV is positive.Merseyside: Has the flexibility option of: 1. 3. 2. Ease of doing up-grade of existing technologies. According to a consultant.5 million. and EPS is positive and which provide strategic factors.1:1 technology from Japan that will be implemented within a period of five years. payback period is a maximum of six years. the selling price in the next 15 years will reach £ 35 million. There are opportunities to apply technology from Germany within the next five years.

62 years shorter therefore allowing the Merseyside project to invest in switching to new technologies. Yes.• • • Higher cash flows in the beginning Relatively short payback period Can wait to see if German technology will be better than Japanese technology Production process is old & not continuous at times Higher labor costs • • 4 yr pd) Japanese technology proven successful in Japan Propylene gas pipeline option – decreased need for railroad tank car transportation Lack of flexibility option Committed to project If better technology is developed cannot integrate it Land value Use of right of way Future sale of right of way Weaknesse • s • • • • • • • Opportunit ies • • • • • Modernization Increased output/Lower costs Higher market share Increased competitiveness Technology flexibility 45 day facility closure will cause customers to purchase from competitors Will have to compete to regain lost market share Obsolescence of technology Threats • • • • German technology Loss of right of way Lost cash flows from not implementing the Japanese technology • • 3. The flexibility affect the economic attractiveness of this project because the project chance in getting positive free cash flow is faster and the payback period is . b. Is it possible to calculate the value of managerial flexibility associated with the Merseyside project? How does. Merseyside is the project with a positive free cash flow and faster project payback period of 3. we can calculate the value of managerial flexibility associated with the Merseyside project. this flexibility affects the attractiveness of investment? a.

of course. Proposals submitted by each manager: Elizabeth Eustace in Rotterdam projects: 1.By applying process control technology from Germany it will lower costs and increase output that is equal to 1. NPV. More detailed. Only in volunteer projects to improve facilities and improve the production process are: (1) relocating and modernizing the tank car unloading area which allows the flow of the process of becoming shorter.1:1 to process control technology from Japan . The analysis is shorter 2. But other than that the reporting style of Elizabeth on the Rotterdam project is more detailed and complete. (3) renovating the factory and save energy b. IRR. What is the difference in the way Elizabeth Eustace and Lucy Morris filed their respective projects? How do these style differences affect the decision? a. The project. 4. it is also becoming a consideration in determining which projects will be taken.shorter so that it becomes an attraction for investors since it is the indication to do a better investment. Discussing about the right-of-way for pipeline installation project 3. Diamond Chemicals will become a company leader in implementing new technology Lucy Morris on Merseyside project: 1. consisting of 90 pages of analysis 2. and EPS as well as strategic factors. The decision will be based on which projects will be able to meet the four criteria set by Diamond Chemical. which must be proposed by James Fawn to the CEO and BOD? Parameter Merseyside Project Rotterdam Project .According to the statement that Elizabeth Eustace. Strategic factors: . Payback Period. 5. (2) improve the polymerization tank to obtain a higher pressure.

92% 8.018 £ 0. The potential loss if the Rotterdam project is not implemented within 6 months is £ 3.2 years Positive £ 0. 2.NPV IRR PAYBACK PERIOD EPS Positive > 10% Max.92% 3.99 million 25.5 million.60 million 25. because the German technology is still in research stage and not yet proven to be better than the Japanese technology.029 Of the four project selection criteria set by Diamond Chemicals we can see that the Merseyside project has met all the criteria there. 3. While on the other hand.6 years £ 11. 6 yrs £ 8. There was also a reason that is included in strategic factors. The existence of uncertainty in the Rotterdam project associated with the use of German technology in the period of 5 years to come. namely: 1. Merseyside project has flexibility options that are not owned by the Rotterdam project so it is easy to upgrade the technology. NPV . So we propose to James Fawn to select Merseyside projects. Calculation Formula 1. the Rotterdam project does not meet the Payback Period criteria. Appendixes A.

2. Earning per share = Net Income / Outstanding shares B. IRR IRR is the rate that forces the NPV to equal zero 3. Payback Period Paybacks = Year before full recovery + (Unrecovered cost at start of year / cash flow during year) 4. Graphic/diagram FCF Merseyside vs Rotterdam .

19 2.14 4.25 5.85 -2.21 -0.47 4.05 5.88 2.08 5.39 5.17 4.39 5.68 2013 1.97 2.68 2.35 1.48 1.17 4.81 3.91 1.02 2006 2.6 25.9 1 1.54 2.45 2009 2.68 40.25 1.59 10% 92.25 5.25 5.9% 3.5 2.38 5.39 4.94 -3.5 -8.28 -17.09 -3.96 -9. and EPS Merseyside and Rotterdam Years FCF M1 TH Payback2 FCF R3 TH Payback CF after erosion After-tax profit M After-tax profit R Discount Rate SO4 Subject PV Merseyside NPV Rotterdam PV Rotterdam NPV Rotterdam PV R After Erosion NPV R After Erosion IRR Merseyside IRR Rotterdam Payback Now -9 2001 1.17 4.19 -2.17 5.71 -3.4 -7.35 4.8 4 2.47 2008 2.25 5.83 14.73 -5.17 .91 1.11 -4.21 -11.25 5.91 1.91 1.67 -2.9 2.67 -1. IRR.96 3.06 1.28 2.43 2010 2. Payback.891.65 3.09 -1.66 -4.41 2005 3.9% 17.3 9 -3.C.39 -3.21 4.46 2003 3.27 1.9 2.34 -12.0 £9 £18 £14 15.39 5.46 5.01 4.08 11.6 year 2002 2. Calculation Table Table 1 NPV.68 2012 1.68 2015 1.19 4.6 -8.35 2.17 39.21 2.41 2011 1.17 2004 3.5 1.86 2.49 2007 2.2 40 Result £18.68 -15.68 2014 1.

01 35 0.02 11 0.0494 0.02 85 0.01 35 0.01 35 0.Period M Payback Period R Annual EPS M Annual EPS R EPS Merseyside EPS Merseyside 1 8.02 53 0.02 24 0.0225 -0.0236 0.02 05 0.05 57 0.05 57 0.03 74 0.02 21 0.05 57 0.018 0.05 59 0.02 12 0.05 57 0.02 44 0. 3R = Rotterdam.2 year 0.0234 0.0372 0.05 57 0.0012 0.029 Remarks: M = Merseyside.01 35 0.02 16 0.01 35 0.01 52 0. dan 4SO = Shares Outstanding. .05 57 0. 2TH Payback = Time Horizon Payback.04 80 0.

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