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This Victoria Chemicals PLC (A): The Merseyside Project case study focuses on the project evaluation of a planned improvement of a polypropylene production plant.
Robert F. Bruner
Harvard Business Review (UV1192-PDF-ENG)
August 29, 2008
Case questions answered:
- What changes, if any, should Lucy Morris ask Frank Greystock to make in his discounted cash flow (DCF) analysis? Why? What should Morris be prepared to say to the Transport Division, the director of sales, her assistant plant manager, and the analyst from the Treasury Staff?
- How attractive is the Merseyside Project? By what criteria?
- Should Morris continue to promote the project for funding? Justify your response by revising the analysis if necessary.
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Case answers for Victoria Chemicals PLC (A): The Merseyside Project
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1. What changes, if any, should Lucy Morris ask Frank Greystock to make in his discounted cash flow (DCF) analysis? Why? What should Morris be prepared to say to the Transport Division, the director of sales, her assistant plant manager, and the analyst from the Treasury Staff?
Preliminary Engineering Costs should be eliminated in this analysis because that amount has been spent over the last nine months. Preliminary Engineering Costs is actually the sunk cost and should not be included in the analysis since it overburdens this project.
To have a fair NPV, we also decided to straight-line depreciate the initial amount of 12 million instead of a good-looking NPV due to the manipulation of accelerated depreciation (e.g., double-declining balance depreciation).
The accelerated depreciation generally improves the NPV of a capital project, like The Merseyside Project, compared to straight-line depreciation by generating some tax benefits.
Concerns of the Transport Division
According to Transport Division, the rolling stock needs to be purchased to support the anticipated growth of the firm in other areas, an outcome of this project. Hence, we included the cost of GBP2 million into capital expenditure in 2010.
Furthermore, the 2 million also need to be depreciated over 10 years. Because the rolling stock does not lose value significantly in the first years, gradually in 10 years, we decided to apply straight-line depreciation instead of double-declining balance depreciation.
Concerns of the ICG Sales and Marketing Department
The concern put forth by the director of sales should be considered as well in the DCF analysis because a more efficient Merseyside Project or plant is likely to cannibalize sales from the Rotterdam plant.
Due to the recession, sales will certainly drop. Furthermore, the higher output due to renovation will even lead to an oversupply in the market. The recession is normally lasted 2 years, for this reason, we will lower the sales by 10% for 2008 and 2009.
Concerns of the Assistant Plant Manager
Due to the negative GBP750.000 NPV of the EPC project, we would recommend not to add this project to the Merseyside project analysis because it will worsen the positive analysis of Merseyside.
Although developing EPC may seem a good idea considering the company’s competitive strength, the description from the assistant manager clearly shows that Tewitt will have some personal benefits in the EPC project.
This is also the reason we will not include the EPC project in the Merseyside analysis. Nevertheless, we would suggest Tewitt keep a close eye on this project. Once the crisis is over, the acceptance or rejection of the EPC project from executives might change in the future.
Concerns of the Treasury Staff
Andrew Gowan of the Treasury staff raised a very valuable point in this analysis. A basic rule of DCF analysis is that…
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