Diamond Chemicals is considering two mutually exclusive projects, the Merseyside project and the Rotterdam project, for the production of polypropylene
When considering the Merseyside project, senior-management wants a positive impact on earnings per share. The addition to earnings per share was £28,800 with an average addition of £2,000 per year2. Calculated with erosion, the addition to earnings per share was £18,800 with an average addition of £1,100 per year2. The payback period for the project was 3.10 years, when considering the erosion of Rotterdam, this would increase to 3.46 years2. The net present value of Merseyside is £15.61 million and when considering erosion, the net present value is £11.37 million2. The internal rate of return is 33%, with the erosion, it is 28.2%2. Based on these four criteria, Merseyside is a valid project to consider.
When considering the Rotterdam project, the effect on earnings per share was £6,000 with an average addition of £2,100 per year4. With the erosion of Merseyside, the earnings per share would be -£2,700 with an average addition of £1,200 per year4. The payback period of the Rotterdam project would be 13.68 years and with erosion, it would be 14.24 years4. The net present value is -£3.24 million and when considering erosion, it was -£6.61 million4. The internal rate of return is 8.04% and with erosion 5.91%4. The Rotterdam project does not meet the criteria due to a negative net present value.
After analyzing each project, we would recommend that Diamond Chemicals accept the Merseyside project and reject the Rotterdam project. The Merseyside project has a higher net present value, higher internal rate of return, a shorter payback period, and larger earnings per share. These projects are mutually exclusive and even if they were independent, we would still reject the Rotterdam project due to its negative net present value.
After conducting a sensitivity analysis for inflation, we reaffirmed our decision to accept the Merseyside project. Even if the inflation rate deviates 50% in either direction, Diamond Chemicals will still have a favorable net present value and internal rate of return. If the inflation deviated -50% making our inflation 1.5%, the net present value would be £12.02 million, the internal rate of return of 29.1%, payback period of 3.35 years, and an earnings per share of £23,0005. If the inflation deviated +50% making our inflation 4.5%, the net present value would be £19.7 million, internal rate of return of 36.9%, payback period of 2.89 years, and an earnings per share of £36,0005.
If Diamond Chemicals chooses to accept the Merseyside project, value would be added to Merseyside in the amount of £15.61 million and £11.37 million as a whole to Diamond Chemicals after accounting for the erosion of Rotterdam.
Diamond Chemicals was under pressure from investors to improve its financial performance because of both the worldwide economic slowdown and the accumulation of the firm’s common shares by a well-known corporate raider. They were considering two projects, one at Merseyside and one at Rotterdam, which would increase output by 7% at each facility. A companywide increase in polypropylene output of 14 percent made no sense, but a 7 percent increase would. This would make the two projects mutually exclusive. Bruner: Case Studies in Finance
Diamond Chemicals PLC:
Diamond Chemicals is a leading producer of polypropylene and a major competitor in the worldwide chemicals industry. Polypropylene is a polymer used in a wide variety of products such as medical products, film, carpet, and automobile components. Diamond Chemicals currently purchases propylene from four refineries in England. Propylene is produced through the course of refining crude oil into gasoline. They use two main production facilities one in Merseyside, England and the other in Rotterdam, Holland....