Victoria Chemicals plc-Merseyside and Rotterdam Projects - Case Study Example

Case Analysis: Victoria Chemicals plc-Merseyside and Rotterdam Projects Introduction This case is about two mutually exclusive projects-the Merseyside and Rotterdam projects. The case requires the measurement of the attractiveness of each of the two projects based on their investments before the proposal is presented to the Chief Executive Officer. James Fawn the vice president of the Intermediate Chemicals Group (ICG) and John Camperdown, the financial analyst met to review the two projects. The proposals submitted by plant managers from both Liverpool and Rotterdam required an expansion of the polypropylene output of the respective plants by 7%. The strategic analysts in Victoria Chemicals held the view that an increase in polypropylene by 14% would not make sense though a 7% would do. This would compel them to approve one of the projects. The rational analytical process to use in extricating the ambiguities of the present measures of investment attractiveness of the two projects will be done through a thorough analysis and evaluation in terms of their net present value, payback, growth in earnings per share and internal rate of return to determine which of them is attractive for investment. After the evaluation, the best project based on its attractiveness will be chosen. 1. The proposal from Merseyside, Liverpool This project would retain its flexibility in order to add technology in the future. The investment criterion for this project is as follows: Average annual addition to EPS GBP 0.22 Payback period 3.8 years Net Present Value GBP 10.5 million Internal rate of return 24% The contribution to net income for the project is a positive one. This is based on the calculation carried out by the average annual earnings per share contribution of the project over the economic life of the project using the number of outstanding shares at the recent financial year. The payback period which is the number of years which are necessary for free cash flow of the project to amortize the initial project outlay completely for the project is within the maximum payback period which is six years. The Net Present Value of the company is positive an indication of a better performing project. The internal rate of return of the project which is 24% is more than 10% and this is an indication of how attractive the project is. A summary of the performance of the Merseyside project is as follows 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 Based on the above analysis, it is quite evident that Merseyside project is quite attractive in terms of its performance and this makes it a good project for investment. The Merseyside project will be of great help to Victoria Chemicals as it would lead to an increase in free cash flow, increase in gross profit and increase in output for the company. The increase in output would see the company operate in full efficiency and to remain competitive in the market. Even though the Merseyside project seems promising in terms of output and return, the plant operations will be disrupted in the course of upgrading the technology in the company which will then affect the total output of the company. The period at which the plant will not be operating will mean that the company will temporarily lose its business from the close of the customers. The temporal close of business and clients may be a cost to pay by the company as it may end up losing the customers due to the inconveniences caused. The table below shows the assumptions made towards the DCF Analysis of the Merseyside Project: Annual output in metric tons 250,000 Output gain 7% Gross margin rate 12.5% The gross margin rate and the output gain are standard and this means that the company (Victoria Chemicals) will not take a long time before it enjoys the full benefits of the investment. This project seems to be ideal for the company given the fact that the upgrade will take place in one phase to ensure no other plant operations disruption takes place. 2. The Rotterdam project The Rotterdam project is firmly committed to Victoria Chemicals on its new process of technology. The performance of this project is expected to be as follows: Payback period 3.0 years Net Present Value GBP 11million Internal rate of return 15.4% The expenditure of the project will be spread over a period of three years. The payback period for the project which is 3 years is within the time frame which is the maximum of 6 years. The internal rate of return which is 15.4% is more than 10% an indication of a good performance of the project. The output from this investment is expected to increase at a 7% annual increase as the new technology is installed. The proposal of a phased-investment program will ensure that the plant operations are not disrupted in the way to increase the use of technology. The phased-investment would lead to the reduction of costs and enable it to operate in full capacity and efficiency. 2008 2009 2010 2011 2012 Output 255,000 260,100 265,302 267,500 267,500 New Gross Profit 11.62 13.7 16.01 22.04 22.71 Old output 250,000 250,000 250,000 250,000 250,000 Free cash flow -3.50 -12.07 -4.34 -2.7 3.25 Incremental gross profit -7.79 -5.7 -3.4 2.64 3.31 The above table shows a brief summary of the performance of the project at Rotterdam. Based on the performance, it is quite evident that the performance of the company is good for investment. The increase in the free cash flow from 2010 to 2012 is a clear indication of how the project is performing well and this makes it a good project for investment. The table below is a summary of the assumptions made towards the Rotterdam project: Gross margin growth rate per year 0.6% Maximum possible gross margin 15% Gross margin 11.5% Output gain per year 2% Annual output in metric tons 250,000 Maximum possible output 267,500 The output gain from this project is low and the same is the gross margin. The output gain per year is even too small for Victoria Chemicals to acquire its goals of full utilization and efficiency through operating at full capacity. If the project is adopted, then it would mean that the company will take a long time before it enjoys the benefits from the investment. Conclusion The expected output from each of the two plants is 7% which translates into 14% which is too high for the company. It is therefore important for the management to choose on project to work on based on its attractiveness in terms of performance. As a consultant and based on the above analysis, I would recommend the management to go for the Merseyside project. Even though it is coupled with several disadvantages, the overall performance of the project is better than that of the Rotterdam project. The main aim of the project is to improve efficiency, cash flow and financial performance at large. The Merseyside project seems to fulfill this aim to totality. The internal rate of return from the Merseyside project is more than that of the Rotterdam project and that is why the cash flow increase for the project is higher than that of the Rotterdam project. Works Cited Moyer, Charles, McGuigan, James, Rao, Ramesh and Kretlow, William. Contemporary Financial Management. Cengage Learning, 2012, pg 6 Read More