Professional Documents
Culture Documents
Group 5
Edi Suryanto
Gressiadi Muslim M
Fahmiansyah
Rudianto Nugroho
Wibowo Kristianto
2011
Andrew Cowan assume long-term inflation rate expected is 3 percent per year.
Thus, the real target rate of return of Diamond Chemical (with, zero inflation) is 7
percent. Greystock decided to continue using the discount rate by 10 percent,
because it is promoted in the latest issue of capital budgeting manuals Diamond
Chemicals.
In accordance with the analysis Greystock, Merseyside project meets all four
investment criteria:
1. Additional average annual EPS = 0.018 pounds
2. Payback Period = 3.6 years
3. NPV = £ 9.0 million
4. IRR = 25.9 percent
The complexity of the technology owned and levels through the mill of a system
would be very expensive to be dismantled. Practically, once the decision was made
to install it will not be refunded. Fawn remind "strategic factors" that Eustace mean
by a clear cost and increased output expected from the new system, as well as from
profits generated as the first European major manufacturers use new technology.
The designer team of German engineers from Glusingen University has tested all
these processes and systems to surpass Japan in reducing costs and improving
quality with a factor of 1.1:1. If the rumors are true, the system will be available
commercially within five years. When it is possible to apply the German technology
in five years, it means letting go off the Japanese investment in the system.
Lucy Morris, manager of the factory on Merseyside, chose to "wait and see" how the
German technology develops. Fawn believes that the flexibility of technological
change differ between plans Rotterdam and Merseyside, and this gives a different
effect on the value of each plan.
Key Issues/problems
1. Why Merseyside and Rotterdam projects called mutually exclusive?
2. How do the two projects are compared based on investment criteria Diamond
Chemicals? What may be taken into account to distinguish it in the rankings?
3. Is it possible to calculate the value of managerial flexibility associated with the
Merseyside project? How, this flexibility affects the attractiveness of investment?
4. What is the difference in the way Elizabeth Eustace and Lucy Morris filed their
respective projects? How do these style differences affect the decision?
5. The project, which must be proposed by James Fawn to the CEO and BOD?
Analysis
1. Why Merseyside and Rotterdam projects called mutually exclusive?
Mutually exclusive projects mean that the acceptance of one project eliminates the
others from consideration. Projects are said to be mutually exclusive when they
cannot be undertaken simultaneously. The projects are called mutually exclusive
because they have to choose one project on the grounds:
e. World economic situation is declining; this might impact the market share of both
projects.
f. The location of the two separate projects is in the UK and the Netherlands. This
also affects capital budgeting because the location of two separate factories will
lead to higher costs and each state has different policies therefore it must choose
one project alone
g. Rotterdam’s project to change the system from the use of polypropylene supply
tank on the train was replaced by using the pipeline including the purchase rights of
way which cost £ 3.5 million. In this case Elizabeth Eustace has already bought the
pipeline right of way. If the Rotterdam project is not implemented then the right of
way will be lost and deadlines 6 months. So there is the possibility of losses for the
company.
3. Payback Period is the number of years owned by the company to earn back the
investment in the project. Payback does not capture the entire flow of cash flows of
a project and therefore not a recommended method in the evaluation of a project.
Note, though payback measures the liquidity of a project, and therefore many
companies use it as a measure of risk.
4. EPS or earnings per share is net profit level for each sheet of the company shares
that can be achieved when running the operation. Earnings per share or EPS was
obtained from the profit attributable to ordinary shareholders divided by the
weighted - average common shares outstanding.
5. Strategic factors are other factors that provide value-added when the project is
implemented.
Rotterdam:
1. Improvements in gas supply line of polypropylene that were using the railway
facilities which must go through three refineries to provide gas for a single refinery.
This gives the assurance of continuous supply for the plant in Rotterdam.
2. Supply through pipe line project includes the right of way for £ 3.5 million; it is
the price when the sale has reached £ 6 million. According to a consultant, the
selling price in the next 15 years will reach £ 35 million.
3. Application of technology from Japan that has been proven over 3 years to
provide increased output and reduced costs and save energy. Besides, there are
opportunities in the application of German technology in Rotterdam project through
an analog process-control system that offers benefits in increased output and
reduced cost compared with a ratio of 1,1:1 technology from Japan that will be
implemented within a period of five years.
Merseyside Rotterdam
• Increased competitiveness
• Technology flexibility
• Will have to compete to regain lost • Lost cash flows from not
market share implementing the Japanese
technology
• Obsolescence of technology
4. What is the difference in the way Elizabeth Eustace and Lucy Morris
filed their respective projects? How do these style differences affect the
decision?
a. Proposals submitted by each manager:
Elizabeth Eustace in Rotterdam projects:
1. More detailed, consisting of 90 pages of analysis
2. Discussing about the right-of-way for pipeline installation project
3. Strategic factors:
- By applying process control technology from Germany it will lower costs and
increase output that is equal to 1,1:1 to process control technology from Japan
- According to the statement that Elizabeth Eustace, Diamond Chemicals will
become a company leader in implementing new technology
Lucy Morris on Merseyside project:
1. The analysis is shorter
2. Only in volunteer projects to improve facilities and improve the production
process are: (1) relocating and modernizing the tank car unloading area which
allows the flow of the process of becoming shorter, (2) improve the polymerization
tank to obtain a higher pressure, (3) renovating the factory and save energy
b. The decision will be based on which projects will be able to meet the four criteria
set by Diamond Chemical, NPV, IRR, Payback Period, and EPS as well as strategic
factors. But other than that the reporting style of Elizabeth on the Rotterdam project
is more detailed and complete, of course, it is also becoming a consideration in
determining which projects will be taken.
5. The project, which must be proposed by James Fawn to the CEO and
BOD?
Of the four project selection criteria set by Diamond Chemicals we can see that the
Merseyside project has met all the criteria there. While on the other hand, the
Rotterdam project does not meet the Payback Period criteria. So we propose to
James Fawn to select Merseyside projects. There was also a reason that is included
in strategic factors, namely:
1. Merseyside project has flexibility options that are not owned by the Rotterdam
project so it is easy to upgrade the technology.
2. The existence of uncertainty in the Rotterdam project associated with the use of
German technology in the period of 5 years to come, because the German
technology is still in research stage and not yet proven to be better than the
Japanese technology.
3. The potential loss if the Rotterdam project is not implemented within 6 months is
£ 3.5 million.
Appendixes
A. Calculation Formula
1. NPV
2. IRR
3. Payback Period
B. Graphic/diagram
Subject Result
PV Merseyside £18,0
NPV
Rotterdam £9
PV Rotterdam £18
NPV
Rotterdam £14
PV R After
Erosion 15,08
NPV R After
Erosion 11,6
IRR
Merseyside 25,9%
IRR
Rotterdam 17,9%
Payback 3,6 year
Period M
Payback
Period R 8,2 year
- 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,01 0,01 0,01 0,01 0,01
Annual EPS M 0,0012 0,0225 0,0236 44 53 05 11 16 21 24 35 35 35 35 35
- - 0,01 0,02 0,02 0,03 0,04 0,05 0,05 0,05 0,05 0,05 0,05 0,05
Annual EPS R 0,0494 -0,0372 0,0234 52 12 85 74 80 57 59 57 57 57 57 57
EPS
Merseyside 0,018
EPS
Merseyside 0,029
Remarks: M = Merseyside, 2TH Payback = Time Horizon Payback, 3R = Rotterdam, dan 4SO = Shares Outstanding.
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