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Diamond Chemicals Plc - Case Study

Essay by   •  February 1, 2016  •  Case Study  •  325 Words (2 Pages)  •  1,178 Views

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Problem Statement: 

Diamond Chemicals plc wants to modernize its product line with the Merseyside project. After analyzing the project and making FCF, they consider that this project meets all of the four investment criteria set by the Diamond Chemicals, the computation of Net Present Value (NPV) on the basis of appropriate cost of capital, Internal Rate of Return (IRR), Payback Period and the annual growth in the Earning per Share (EPS).

Analysis and Recommendations:

Nonetheless, the Greystock’s DCF analysis of the Merseyside project is dissatisfactory, so there are some factors needed to consider:

As mentioned in case, the discount rate, 10 percent, impounds a long-term inflation expectation of 3 percent per year as a nominal target rate of return. Thus, this 3% inflation should be considered and result sales will increase every year since inflation.

Furthermore, the transportation of polymer will increase if Merseyside project is undertaken and will require additional investment for acquisition of tank cars and the investment have been estimated as £2 million and new cars will have an economic life of 10 years. Since, the transportation division incurs cost and Diamond Chemicals will have to provide the resource in order to meet the transportation need; therefore, an outlay of £2 million and depreciation of the new tanks has also been incorporated in the projected cash flows of Merseyside project and the investment outlay will change to £11 million.

In addition, the EPC project should not be accepted into the Merseyside project. Although EPC can increase the cash flows by £25,000 but the NPV is -£750,000, which makes it invaluable.

After recalculate the discount cash flow, here is the result:

NPV = £10.19 million > 0

IRR = 23.7% > 10%

Payback Period = 4.3 years < 5 years

EPS = £0.0251/share > £0.018

Therefore, I recommend that this Merseyside project should be undertaken because it meets all investment criteria and increases to the shareholder value, also it is likely to introduce efficiency and result in a long-term gain to the organization.

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