Victoria Chemicals Case Analysis

Topics: Net present value, Discounted cash flow, Internal rate of return Pages: 5 (1349 words) Published: September 2, 2012
Case Studies Report:
Victoria Chemicals

This report will be covering the several capitals investment aspects in which are associated with the case – Victoria Chemicals PLC (A): The Merseyside Project, written by Robert. F. Bruner.

In the case, Victoria Chemicals, a fictional company, were under the pressure of its investors to improve its performance as the earnings per shares (EPS) has decreased from 250 pence in 2006 to 180 pence in 2007. Victoria Chemicals is a producer of polypropylene that has two factories in Merseyside Works and Rotterdam, Holland. In addition, there are seven major competitors in the market producing polypropylene.

As previous management has limited capital expenditure for Victoria Chemicals, hence the company has not potentially grown to its optimal state of producing with maximum production profitability. As such, the new plant manager, Lucy Morris plans to propose a project in which has a capital expenditure of GBP12 million to refurbish the current status of the polypropylene producing plant in Merseyside. Cost and benefits of the capital project will be contemplated in this report along with any issues relating to the undertaking of the project. All figures in this report are obtained from Exhibit 2 of the case study.

Nominal Benefits of the Project
the benefits offered by this project are energy savings and improvement of gross profit margin of the Merseyside plant. Annual energy savings of 1.25 percent of sales amount in the first 5 years which is estimated to be at £2.11M (1.25%*£168.75M) and 0.75 percent of sales amount in the additional 5 years (£1.27M) are of expectation from the project. In addition, gross profit margin, which is the difference between revenue and cost, will increase by 1 percent from 11.5 percent, which averaged to an incremental gross profit annually of £4.16M for the next 15 years.

Victoria Chemicals and Capital Expenditure Proposal
In order to obtain approval of the proposal to be implemented, the project has to meet three out of four of the following criteria: earnings per share (EPS), payback period, net present value (NPV) of projects, and internal rate of return (IRR). Earnings per share refers to the amount of profit earnings for each outstanding company’s stock, in this case, the EPS of Victoria Chemicals has declined by 28 percent. Payback period is the number of years needed to recover the cost of the project. These two methods are less favorable as the evaluation processes are complicated and the payback period does not take into account the time value of money which is unrealistic. NPV is the worthiness of the project in dollar amount after discounting all future cash flows. If a company’s NPV is positive, it means that the amount of cash flows generated by the project is positive and should add value to the company. Finally, the IRR refers to the discount rate in which the project has to surpass in order to gain additional profits from its undertaking. The NPV and IRR is a more favorable approach to appraise the project as it takes into account all the underlying cost and future potential cash flows of the project and evaluate the worthiness of actually implementing the project.

Transport Division and the Project
If the engineering efficiency project were to be implemented; the annual output of polypropylene of Victoria Chemicals will increase by 7 percent to 267,500 tons. As a result, the increment in production has to be sustained by increasing the number of tank cars to the Merseyside plant for logistics purposes. We discard any possibilities that the tank cars used by Merseyside plant can be communal with the Rotterdam plant as the Rotterdam plant is operating close to its capacity and the two plants are assumed to be logistically separated. With the additional tank cars needed to transport raw and finished goods between the Merseyside plant and its clienteles, there will be additional cost associated...
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