Case 22 Victoria Chemicals (A


Jordan Green Shaquita Harris Sharde Lymon Donald Pritchard MGMT 4700 3/21/12

Victoria Chemicals and its Capital Expenditures Victoria Chemicals incorporated four different types of methods to determine its capital budgeting proposed projects. Holland. When Victoria Chemicals started up in 1967 they built two plants. Facing pressure from the investors and wanting to increase production efficiency. II. Neither one of these scenarios occur for the proposed Victoria Chemicals project.I. The payback period and EPS are not used in the final determination of accepting the project because of their shortfalls. This is because EPS focuses on the current cash flows instead of the direct cash flows. Using NPV is a good method to use to evaluate the project because it takes in account for all the costs relevant to the project and includes all the cash flow of the project as seen on exhibit 1. NPV. We would also include the IRR because of the beneficial picture that it creates. Net Present Value. Payback Period. However. Introduction Victoria Chemicals is one of the leading producers of Polypropylene. automobile components. Pay Back Period (PBP). We will see soon enough that Greystock’s Analysis had many flaws that needed to be fixed and how it really should have been done. there can be a complication if two scenarios arise. Earning per Share. The reason why Pay Back Period isn’t a determining factor in accepting a project is because it doesn’t take into consideration the time value of money and also ignores any Cash Flow that occurs after the payback period has been reached. packaging film and more. one in Merseyside. the controller of the Merseyside plant had notice a decline in the stock price from 250 pence per share in 2006 to 180 pence per share in 2007 and knew he had to do something. Of the four methods. After taking all the costs and benefits into consideration. a polymer that is used in many products ranging from carpet fibers. and the Internal Rate of Return (IRR). III. The first complication can be realized when there is a negative Cash Flow other than the initial year of the implementation of the project and dealing with a mutually exclusive project. he decided to renovate the Merseyside plant so Victoria Chemicals can lift itself back to where it once was and continue to be one of the major competitors in the worldwide chemical industry. Greystock put together his own analysis in which he based it on four different components. and Internal rate of return. Soon after many people looked at his analysis they had several questions and suggestions to give to Greystock. Transportation Division Dispute The Transport Division suggestion is that the tank car purchases should be included in the initial outlay because the increased output will exhaust the capacity of the current tank cars and . England and one in Rotterdam. the two favorable to use for evaluation would be NPV and IRR while the EPS and PBP would be less favorable to use because of its evaluation process. They include Earnings per Share (EPS). Both plants were identical to each other and produced an equal amount of goods. When using EPS to evaluate a project it will be more biased towards shorter term project. Morris Greystock.

thus will make the company purchase them in year 2010 instead of 2012. Historically inflation rates are around 2 to 3%.81.94 as seen on exhibit 2. he did not take this into consideration. While Greystock argues that it shouldn’t be included because it will initially use the excess capacity of the Transport Division. the suggestion of director of Sales has merit and is evident that Greystock made a mistake in not including cannibalization in its cash flow. The important thing to notice is undertaking this project will increase the plant size which directly coincides with the increase in bonus being tied to it. Griffin Tewitt the assistant plant manager proposed to modernize the separate and independent part of the Merseyside works which was the production line producing ethylene-propylenecopolymer rubber (EPC). Tewitt argued that the positive NPV of the poly renovations would be able to sustain the negative NPV of the EPC project. it would still result in a negative project NPV. Another problem is that it would not be very honest because the firm would be hiding critical information from the investors. This presents a conflict of interest which is also an agency problem. He stated that “Cash flows and discount rates need to be consistent in their assumptions about inflation. He believes it’s not necessary to accept the project because it will create internal cannibalization. Concerns of the Treasury Staff After looking over Greystock’s analysis. This proposal would cost GBP1 million and would improve cash flow by GBP25. Greystock on the other hand believes that cannibalization is not a relevant cash flow. Facing Cannibalization The director of sales suggest that if the project is accepted then it means they will have to shift capacity away from the Rotterdam plant and towards in Merseyside in order to compensate for the increased output volume. The most likely case scenario would produce a possible 50% internal cannibalization and would produce a NPV of 12. As we see on exhibit 2. Even this advantage. This shift in time will alter the timing of the cash flows and will have a direct affect on the incremental depreciation as seen on exhibit 1.000 ad infinitum and would allow them to produce the EPC at the lowest cost in the world. the worst case scenario of 100% internal cannibalization still produces a positive NPV of 8. Trying to stay consistent in the analysis we decided to use a 3% inflation rate and a nominal . Andrew Gowen of the treasury staff had a couple suggestions about what rate should be the one being used. This process of shifting resources would result in an internal cannibalization. After reviewing the calculation. however in Greystock’s analysis. The director of sales also warns of an oversupply in the market due to stiff competition and the recession that is affecting the economy. This would mean that the real target rate for the company would be at 7%. From this we can conclude that Dewitt has self-driven motives for undertaking this project instead of looking out for the company and thus we suggest rejecting this proposal. IV. V.” which is correct.

the first eight years they were using the DDB method and at the last two years straight-line were used.rate of 10%. As seen on exhibit 4.25% of sales for year 5 and 0. The breakeven point of price per ton is at $457 as seen on exhibit 4. This is more accurate since inflation is something that is a constant so to assume 0% inflation is just unrealistic. We decided to let the base year for inflation to be the year before since we thought that it would make more sense to have inflation at the beginning of 2008 instead of it starting in 2009. Once we took into account cannibalization. Exhibit 5 shows as the discount rate and cannibalization increases the project’s NPV decreases. Lastly we would get the change in WIP to the correct amount after taking all the changes into consideration.5% to 12. pretax cash flow had to be calculated properly as seen on exhibit 1 with the new values and since we now added the tank cars into depreciation. The benefits of the Merseyside project to Victoria Chemical include an increase in manufacturing throughput of 7% and the project is expected to improve the firm’s gross margin from 11. an inflation rate had to be added. As stated in the case. engineering costs is a sunk cost which is not added in determining the NPV of the project because it would be spent regardless of whether they go through with the project or not. it was discovered that the only situation which causes the project to be of no value is when deflation occurs. there is no need to add overhead costs into this analysis and secondly. we know that inflation must be counted on in the first year. The discount rate has an impact on the new project’s value as well especially when looked at with the cannibalization. All of these benefits will be reflected as income revenue on the income statement. which is very important since we want to know how much is Rotterdam losing out on by renovating Merseyside. capital expenditure of GBP2 million needed to be added for 2011. VI. The reason for this is because overhead is more to do with allocation.5%. First of all. These changes are critical in Greystock’s analysis and give out a much more accurate NPV and IRR as seen in exhibit 1 when compared to his original. Greystock originally did not include depreciation of tank cars which needs to be included here since they are now accelerating the date of when they would need more tank cars from 2012 to 2010. Another benefit to be realized from the project is an energy savings increase of 1. There were two minor changes that needed to be made and that was the removal of overhead costs and engineering costs. price per ton is more sensitive to the project NPV and IRR than the inflation rate is.75% of sales for years 6-10. The . the inflation is not a determining factor in the NPV. we needed to reduce the work in process of Rotterdam according to the percentage of cannibalization we thought would be taking place and in our analysis we decided to make it 100%. Our next step was to take into account cannibalization. Greystock’s analysis had to take on a large overhaul. Concerns of the Assistant Plant Manager After taking everyone’s input into consideration. As seen in exhibit 3. In comparing the change of inflation rate and NPV. After making many changes to the sheet. The next thing that had to be changed was depreciation for the tank cars.

63 |23% 8.94 |26% 12.77 |27% | | | | | | | | | | | | | |Cannibalization | | | | | |60% |70% |80% |90% |100% 12.7% | | . Exhibit 2 | | | | | | | | | |0% |10% |20% |30% |40% |50% |NPV |8.81 |IRR |21.7% 17.12 |25% 11.60 |28% 13.08 |30% 16.81 | | | | | | | | | | | |IRR |21.81 |22% Exhibit 3 | | | | |NPV |8.46 |23% 9.projects NPV maintains positive even at the worst case scenario of discount rate at 20% and 100% cannibalization as seen in exhibit 5.42 |29% 14.25 |29% 15.29 |24% 10.

she discovered many opportunities to improve the polypropylene production.09402 |17. The disadvantages to this proposal would be that the plant would be shut down for 45 days.2% |21.2% |23. When Lucy Morris took over her position as plant manager. Some improvement stem from deferring maintenance over the preceding five years.3973 |11.5% |5. In order to remain relevant and profitable in such a competitive market.588962 |5.23196 |12.7% |19. Victoria Chemicals needs to update its antiquated plant design. Refurbishing the polymerization tank to achieve higher pressures and thus greater output.0% |3.0% |4.312308 |8.4% |23.238871 |5. Renovating the compounding plant to increase extrusion throughput and obtain energy savings. Now what was deferred is going to be essential. Relocating and modernizing tank-car unloading areas.4% |20.599736 |7. causing the factory to have higher labor content. Their factory at Merseyside consists of old production only semi continuous.0% |21.7% |22.04744 |8.0% |4.5% |3.0% |1. The improvements are proposed to be GPB12 million by plant manager Lucy Morris.806024 |9.588987 |10. it would save energy and improve process flow. a polymer used in a wide variety of products.9% |24. 3.5% |1.908864 |6. 2. Included in the improvements would be: 1.0% |2. By making improvements.5% |4. thus . Capital expenditures by the company only consisted of the most essential.6% | | | | | | | | | | | Executive Summary: Victoria Chemicals is a leading producer of polypropylene.| | | | |Inflation | | | | | | |0.0% |0.5% |2.9% |18. which would enable process flow to be streamlined.1% |17.

His project would give Victoria Chemicals the lowest EPC cost base in the world. NPV gives explicit consideration to the time value of money. The proposed project has objections by different divisions of Victoria Chemicals. With the market in a downturn. The advantages would be lower energy requirements and 7% greater manufacturing throughput. The third objection is by the Assistant Plant Manager Griffin Tewitt. but his NPV for the project was (GBP750. The first division that is concerned is the Transport Division. they believe they will have to purchase new tank cars. The internal rate of return for this project is 24%. They could increase their allocation of tank cars to Merseyside. It is measured by subtracting a projects initial investment from the present value of the cash inflows discounted at a rate equal to the firms cost of capital. and the industry is in a downturn. the contribution to net income has to be positive. then the firm can believe that this is an acceptable project. This is ignored in the analysis. Also. He believes his project should be included in the renovations. and 10% is continued to be used. For engineering-efficiency projects. He has been engrossed in renovating the ethylene-propylene-copolymer rubber (EPC) part of the plant.5%. IRR is going to be important. but with the anticipated growth of the firm. If the NPV of the project is greater than zero.5% to 12. . the project is expected to improve the gross margin from 11. can they actually sell it? The market for polypropylene is extremely competitive. The higher the NPV. The IRR is the discount rate that makes the net present value equal to zero. The second division with concerns is with the sales and marketing departments. IRR is important to this project because it includes risk. They point out that although the project assumes Victoria Chemicals can sell the added output they are predicting. The final objections are by the treasury staffs who believe that because of inflation the discount rate should be 7% instead of 10%.000).22. Problem Statement: Will undertaking the capital program to improve productions at Merseyside improve the financial performance of Victoria Chemicals? Will taking on this project cause a loss of business volume? Data Analysis: The expected Net Present value of this project is GBP10.5 million. where clearly this project achieves that.running the risk of losing customers. the better the return for stockholders. which this is. They think that this will cause cannibalization within the company. The addition to Earnings per share of this project is GBP0. The IRR must be better than the hurdle rate of 10%.

the NPV would be GBP8. This means Victoria Chemicals will earn 1. The addition to Earning per share. accomplishing this project now would lead to an increase in sales when the market turns around. Victoria Chemicals has always done its books with each division fending for itself. f you were to account for full erosion of Rotterdam’s business volume.3. Overall. The shorter the payback period. If they believe that an allocation of tank cars needs to be made. Although the market is in a downturn. it is important to remember some guidelines about relevant cash flows. the better a project is believed to be. the project met all four investment criteria the company has set forth.15% on initial GBP12 million invested above and beyond return needed to pay initial investment cost. this could help keep customers. sales volume can be expected to increase. the conclusion is that Victoria Chemicals should go forward with the proposed capital program. then they can put it on their books.The payback period for the program is 3. After the market turns around. the positive NPV. maybe improvements can be made at Rotterdam.15%. one should remember to be suspicious of any item called an “allocation. 3. If the Merseyside factory can become a dominant figure for Victoria Chemicals.8 years. Shutting down the factory completely could lead to loss of sales.82 million and the IRR would be 22. Key Decision Criteria In determining if this project will be profitable for Victoria Chemicals. Recommendations and Action Plan After thorough evaluation of the project. As far as the transportation division is concerned.” The concerns of the Sales and marketing departments were associated with cannibalism within the company. Evaluation of Alternatives The company could look at making smaller improvements over time instead of all the improvements at once. and the acceptable IRR are all factors that lead us to believe this capital program will be successful. When looking at relevant cash flows. more specifically the sales of sister factory Rotterdam. If they could come up with an alternative way to still keep productions moving without the complete shutdown of the factory. If they can provide the market with a cheaper product when it turns around. The profitability index is based upon NPV.8 years would be acceptable. Victoria Chemicals will be in a dominant position in the market and will surely take more market share than before the program. Competitors BP(British Petroleum) . The profitability index for Merseyside is 1. This is still a positive NPV for Merseyside and above the hurdle rate. We do not take depreciation into consideration for this evaluation.

00 94.00 288. retail services and petrochemicals products for everyday items. including in biofuels. including exploration and production.277.980. Texas.00 29. energy for heat and light.00 37. The name "BP" derives from the initials of one of the company's former legal names. BP is a global oil and gas company headquartered in London.123.00 95.00 0. petrochemicals.00 1.00 217.00 8.00 24.339.684.338.967. As at 31 December 2010 BP had total proven commercial reserves of 18.384.Other Total Receivables.00 231.00 8. It is the third-largest energy company and fourth-largest company in the world measured by revenues.00 20. which is the biggest producer of oil and gas in the United States and is headquartered in Hothemton.067.00 - As of 200912-31 4.BP is one of the world's leading international oil and gas companies. British Petroleum. refining.050.605.00 .355.489.00 14. Its largest division is BP America.00 16.286. BP has operations in over 80 countries.088.00 25.989.00 42.00 12. Total Gross As of 201112-31 14.212.00 8. providing its customers with fuel for transportation.556.Trade.00 29.00 As of 200812-31 4.532. solar and wind power.8 million barrels of oil equivalent per day and has 22.00 1.806. BP plc Annual Financial Data In Millions of THEMD (except for per share items) Cash & Equivalents Short Term Investments Cash and Short Term Investments Accounts Receivable . It also has major renewable energy activities.07 billion barrels of oil equivalent. Net Total Inventory Prepaid Expenses Other Current Assets.197.753.00 1.00 26.00 1.00 4. distribution and marketing.843. power generation and trading.400 service stations worldwide.00 24.00 67. It is vertically-integrated and is active in every area of the oil and gas industry.661.00 22. Net Receivables . Total Total Current Assets Property/Plant/Equipment. United Kingdom.00 - As of 201012-31 18.574. hydrogen.105.00 66.00 3.218. produces around 3.821.510.

00 14. Net Intangibles.518.935.00 29.00 59.Common Other Equity.598.00 10.594. Net Long Term Investments Other Long Term Assets.00 94.017.879.987.00 26.00 500.00 30.00 23.00 52.932.00 498.878.00 30.464.908.31 .89 As of 200812-31 -113.00 30.00 16.00 30.00 46. Total Goodwill.00 6.90 As of 201012-31 8.759.937.00 5.555.00 9.00 18.00 7.169.00 111. Total Total Current Liabilities Long Term Debt Capital Lease Obligations Total Long Term Debt Total Debt Deferred Income Tax Minority Interest Other Liabilities.627.213.00 9.987.In Millions of THEMD (except for per share items) Accumulated Depreciation.078.303.00 272.00 235.00 6. Total Additional Paid-In Capital Retained Earnings (Accumulated Deficit) Treasury Stock .00 0.198.796.465.418.710.926.00 10.00 18.00 228.874.130.710.037.00 134.260.00 101.346.00 45.743.238.00 527.00 806.921.00 9.00 6.453.00 15.00 5.00 20.612.Common Stock Primary Issue Total Common Shares Outstanding As of 201112-31 12.00 18.00 18.00 83.109.968.730.465.730.00 290. Total Preferred Stock .00 228.00 136.00 44.00 179.00 290.681.517.716.00 101.00 8.793.00 14.00 0.00 904.00 33.00 -21.336.00 91.00 272. Net Common Stock.00 1.00 17.00 21.46 As of 200912-31 -122.763.927.740.975.620.00 34.320.00 11.00 69.00 16.613.674.00 -21.00 35.983.395.839.00 20.00 8.262. Total Total Assets Accounts Payable Accrued Expenses Notes Payable/Short Term Debt Current Port.882. Total Total Equity Total Liabilities & Shareholders' Equity Shares Outs .00 111.00 35.462.102.00 15.00 6. of LT Debt/Capital Leases Other Current liabilities.155.826.275.169.00 15.00 45.00 3.00 9.00 235.00 9.00 5.312.355.00 29.909.927.00 32.648.00 8.00 25.Non Redeemable.780. Total Total Liabilities Redeemable Preferred Stock.548.00 50.405.00 94.00 177.00 25.00 82.355.968.00 18.329.00 5.662.020.626.262.044.00 17.202.

These strengths are supported by their longstanding track record in and applying leading technology. such as the strategic alliance created in 2011 with Reliance in India. which continues to be successful. They are moving forward with their plans to sell around half of their refining capacity in the THEM. Brazil and the Gulf of Mexico.000 meters below the Shah Deniz field in Azerbaijan to markets in Europe.BP Strategies/Plan for recovery after Gulf Oil Spill • Plan to theme around half of the increased cash flow for investment and half for other themes including increased distributions to shareholders. and they have made good progress on the modernization of the Whiting refinery. • Investors will be able to measure balance sheet strength. I want to say a little more about the areas of strength at the heart of their strategy. They they’re disappointed that their exploration plans with Rosneft did not progress. During the year they also announced they will be investing approximately $14 billion – with their partners – in the UK North Sea. For example. they move gas from 6. their world-class fuels. As the BP Energy Outlook 2030 shows. They intend to more than double exploration investment over the next three years. they are forging new partnerships. In giant fields. They continue to have a significant facts on developing unconventional resources around the world. Taking technology and skills developed in North America. work with their partners has increased output at Iraq’s Rumaila field by more than 10%. They are also being selective in where they invest along the supply chain. BP was the first super major to exceed its production target in Iraq. The plan makes a greater priority of creating value for the shareholder. 3. They also have exceptional expertise in building supply chains. and they are selling a number of refining and marketing assets that do not match their aspirations. This opened up around 315. For example. and they also continue to work in Indonesia to develop their onshore coal bed methane fields. 2012 will be a good year for them in the deepwater regions of Angola. they are selling certain mature fields that hold more value for others. Looking ahead. They had a record year for new access in 2011. gaining 55 exploration licenses in nine countries.000km2 for exploration. In Refining and Marketing. and the deep and enduring relationships they form. the world is now in a long wavelength transition to a low-carbon energy mix. lubricants and petrochemicals the mines are shifting the balance of their activity towards higher growth markets. engineer and operate large installations safely. Exploration is their lifeblood. Here. For BP. they expect their downstream operations to be a material contributor to the cash flow they anticipate over the next few years. They will sell assets earlier in their lifecycle following discovery if they spot opportunities to reinvest in higher growth areas. including China and India. In deep water. that means helping to meet current demand through the supply . they are working with the governments of Oman and Algeria to develop their large tight gas reservoirs.000 kilometers away. rather than simply increasing production volume. they are confident in their ability to design. Natural gas is set to be the fastest-growing fossil fuel globally to 2030. but they remain committed to their TNK-BP investment in Rthemsia.

They market and sell their products in more than 100 countries. the demand for their products continues to grow.6 billion. superior technology base and reputation for operational excellence enable them to deliver exceptional value to their customers across the petrochemical chain – from refining to advanced product applications. a global leader in polyolefins technology. As economies around the globe develop. We have annual revenues of approximately $41 billion and more than 14. Fast Facts Annual revenues of $41 billion (2010) Global reach that addresses worldwide needs 58 manufacturing sites in 18 countries on five continents Sales in more than 100 countries Vertically integrated facilities enable conversion of crude hydrocarbons to materials for advanced applications Participation in 16 significant manufacturing joint ventures. technical and commercial infrastructure. with interests in more than 1. They have a growing biofuels business in Brazil and they added 401MWa of wind generation capacity during the year. a leading producer of propylene oxide. polyethylene. and a producer of refined products. from refining to specialized petrochemical product end themes. including biofuels. In contrast. They are geographically diverse with an extensive global manufacturing.of oil and gas – including unconventional resources – while developing a number of the lowcarbon options needed at scale tomorrow. manufacturing flexibility.000 wind turbines now turning across the THEM. LyondellBasell LyondellBasell is the world’s third-largest independent chemical company. supply. and in 2011 they began winding down their remaining solar operations as they prepare to exit the business.600 patents worldwide They participate in the entire petrochemical value chain.000 employees worldwide. ethylene and propylene. which takes total investment since 2005 to $6. primarily in regions that have cost-advantaged raw materials or high growth rates Approximately 9. 11 of which are outside of Western Europe and the United States. They are the largest producer of polypropylene and polypropylene compounds. Their vertically integrated facilities. Additionally.6 billion in their Alternative Energy business. LyondellBasell is a leading provider of technology licenses and a supplier of catalysts for polyolefin production. solar has evolved into a low-margin commodity market. broad product portfolio. During 2011. LyondellBasell Industries NV Financial Data . they invested a further $1.

00 497. Net Receivables .499.00 1.444. Net Long Term Investments Other Long Term Assets.018.In Millions of THEMD (except for per share items) Cash & Equivalents Short Term Investments Cash and Short Term Investments Accounts Receivable . Total Goodwill.00 202.839.00 774.00 4.00 11.00 890.00 22.00 2.00 0.00 2.00 569.040.00 1.252.824.00 270.00 387.00 -417.00 1.557.00 4.414.00 304.00 5.00 7.00 1.00 8. of LT Debt/Capital Leases Other Current liabilities.00 -2.036. Net Intangibles.00 6.277.367.302.039.747.438.891.00 18.00 4.00 290.00 48.00 3.00 3.699. Total Gross Accumulated Depreciation.00 -3.119.00 287.00 2.00 6.00 -1.651.839.00 - As of 201012-31 4.00 11.954.287.585.00 320.00 10.00 13.585.Other Total Receivables.128.00 42.00 3.00 467.00 3.308.861.270.00 18.065.360.00 649.00 53.00 3.00 585.379.601. Total Total Assets Accounts Payable Accrued Expenses Notes Payable/Short Term Debt Current Port. Total Total Current Liabilities Long Term Debt Capital Lease Obligations As of 201112-31 1.00 2.00 - .182.00 2.00 4.778.00 3.00 32.761. Net Total Inventory Prepaid Expenses Other Current Assets.222.Trade.00 595.00 11.00 377.00 8.778.00 1.00 975.287.119.00 27.00 2.00 3.761.00 1.00 305.00 2.00 25.779.00 1.00 4.00 2.165.00 0. Total Total Current Assets Property/Plant/Equipment.00 7.00 - As of 200912-31 558.00 28.00 5.00 - As of 200812-31 858.435.00 3.00 3.980.241.00 0.314.111.662.747.00 2.00 1.00 3.607.00 1.831.00 28.00 2.

00 36.55 As of 200912-31 305.081.00 403.00 81.00 129.837.00 -8.00 6.00 Deferred Income Tax 917.00 Redeemable Preferred Stock.032.00 -6. Total 2.00 Total Debt 4.00 Other Liabilities.00 Total Liabilities 12.23 As of 200812-31 304. Total -427.980.855.737.00 60.00 -6.00 23.00 25.00 6.00 61.451.535.00 9.00 60.00 656.272.440.00 563.00 11.00 564.00 27.00 3.00 2.00 Shares Outs .23 .In Millions of THEMD (except for As of 2011per share items) 12-31 Total Long Term Debt 3.00 30.277. Total 31.00 -298.241.969. Total Preferred Stock .313.082.00 1.00 2.00 28.00 403.00 23.00 Retained Earnings (Accumulated 841.Common Stock Primary Issue Total Common Shares Outstanding 569.761.00 Other Equity.Common -124.839.593.00 34.651.00 0.183.00 Minority Interest 54.34 As of 201012-31 6.00 563.976.00 Additional Paid-In Capital 10.984.00 -9.00 13.00 Total Equity 10.246.00 Total Liabilities & Shareholders' Equity 22.00 Deficit) Treasury Stock .Non Redeemable.00 135.00 -245.302.587. Net Common Stock.

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