Victoria Chemicals - Case Study Example

Case analysis- Victoria Chemicals plc Introduction The case is about the different ways through which Victoria Chemicals plc can fund the modernization of the Merseyside works project from the corporate headquarters in order to improve its financial performance in order to increase its Earnings per Share. Earnings per Share are a portion of profit for the company which is allocated to each outstanding share of common stock. The company had been under pressure from its investors for it to improve its financial performance because of the accumulation of the firm’s common shares by a well known corporate raider. The Earnings per Share had fallen from 180 pence per share by the end of 2007 from 250 pence per share by the end of 2006. To increase its earnings per share, the company required to modernize the Merseyside production process which was old. Lucy Morris, the plant manager at Liverpool believes that the funds for the modernization of the Merseyside Works project could be obtained from the corporate headquarters until several questions were raised. It is therefore quite important for the plant manager and Frank Greystock the controller to address and analyze each question keenly. Based on these issues, Morris will determine the way forward towards modernizing the Merseyside Works project. This way forward includes the analysis of the project in different aspects to determine whether its implementation will be for the good of the overall company. The plant manager will have to choose which category the product lies on based on whether it is a new product or market, market or product extension, engineering efficiency and safety or the environment. The Merseyside Works project is on the engineering efficiency category and will analyzed based on the concerns below. 1. Transport division concerns Victoria Chemicals produces its polypropylene at the Merseyside and Rotterdam works. The Transport Division in the company oversees the transport of all raw, intermediate and finished materials throughout the company. The Merseyside modernization capital project is part and parcel of Victoria Chemicals, and this means that all transport needs should be addressed by the company’s Transport Division. Just as Greystock said, funding from the corporate headquarters in regard to transport is baseless as the project should make use of the company’s excess capacity. All allocations done on the company, and its subsidiaries go to the Transport Division and hence the division should carry the allocation of the rolling stock required for the project. Transport issues will be dealt by the Transport Division of the company hence no need for funding on this sector. 2. ICG Sales and marketing department concerns Modernizing the Merseyside means improved productivity and increased outputs and with lower costs which enable the company to take business from competitors due to the low prices of polypropylene. The added output will help the company in obtaining full efficiencies. Modernization of the Merseyside plant will help Victoria Chemicals in maintaining its cost competitiveness, and this means that the capital project is a worthy course for the sales and marketing department since it would not lead to cannibalization of the other plants. Below is the analysis provided by Greystock on the financial performance of Merseyside works 2008 2009 2010 2011 2012 Output 267,500 267,500 267,500 267,500 267,500 New Gross Profit 21.72 24.83 24.83 24.83 24.93 Old output 250,000 250,000 250,000 250,000 250,000 Free cash flow 1.27 3.92 3.86 3.77 3.08 Incremental gross profit 2.32 5.42 5.42 5.42 5.42 The above table clearly shows how the project will perform. Based on the table above, it is evident that the project at Merseyside works will be of great help to Victoria Chemicals plc. Though it may have its share of disadvantages, the advantages of the project under this concern outweigh the negative ones. 3. Concerns of the assistant plant manager Before proceeding with the capital project, it is important to put all the concerns raised by the assistant plant manager into consideration. The assistant plant manager had proposed the modernization of a separate and independent part of the Merseyside Works which is the production of ethylene-propylene-copolymer rubber (EPC). This product was developed in the early 1960s and was sold in bulk to European tire manufacturers. However, EPC was a small product in the European Chemical Industry. The renovation of the EPC production line would be at a low cost of 1 million GBP and would make Victoria Chemicals have the lowest EPC cost base in the world which would then increase the company cash flows by GBP 25,000. The EPC project line projection will be integrated with the capital project at Merseyside Works to ensure improved and efficient production of both ethylene-propylene-copolymer rubber and polypropylene. Both the capital project at Merseyside Works and the EPC production line are aimed at increasing the cash flow of the company through reduced costs, and prices hence increased sales. Proposal of Tewitt, the assistant plant manager’s proposal to Morris and Greystock is quite a profitable and a good deal for business. According to Tewitt, the capital project in Merseyside Works should be combined with the EPC project as part of the polypropylene line renovations. Combining the two projects will lead to positive NPV of the poly renovations which will help in sustaining negative Net Present Value (NPV) of the EPC project. The combination of the two projects will help the company in exploiting the market after the recession. The concerns of the assistant plant manager are well thought and would highly benefit the company both in the short term and in the long run. With the increased NPV, the company will be able to increase its cash flow which will then increase the financial performance of the company. 4. Concerns of the treasury staff Greystock pointed out that there was the need to have a consistent discount rate and cash flows based on the assumptions of inflation. The company used a 10% hurdle rate which is nominal target rate of return. The Treasury Staff thinks that this rate impounds a long term inflation expectation of 35 % per year which will them make Victoria Chemicals target a return of 7%. The concerns of the Treasury Staff seem meaningful but not for the best of the company which aims at improving its financial performance as well as its cash flow. In this case, the position taken by Greystock to continue with the discount rate of 10% is the best for Victoria Chemical plc because it will help it in achieving the required cash flow which will then help in improving the company’s financial performance. The internal rate of return has to be greater or equal to 10% to enhance engineering efficiency for the company. Conclusion Greystock’s analysis has been put well into consideration as this will help Lucy Morris settle the question regarding the tank cars and the potential loss of business at Rotterdam. Based on the above analysis of all the concerns raised, it is evident that the capital project at Merseyside Works is a worthy business. As the company consultant, I would highly recommend the plant manager to submit the project proposal to the senior management for approval. The project will be beneficial for the company as it will lead to an increase in Net Present value and internal rate of return which will increase the cash flow of the company hence improved financial performance. Works Cited Moyer, Charles, McGuigan, James, Rao, Ramesh and Kretlow, William. Contemporary Financial Management. Cengage Learning, 2012, pg 6 Read More