Victoria Chemicals Case Study

Topics: Net present value, Internal rate of return, Cash flow Pages: 6 (1829 words) Published: November 30, 2010
I. Introduction

Victoria Chemicals is one of the leading producers of Polypropelene, a polymer that is used in many products ranging from carpet fibers, automobile automobile components, packaging film and more. When Victoria Chemicals started up in 1967 they built two plants, one in Merseyside, England and one in Rotterdam, Holland. Both plants were identical to each other and produced an equal amount of goods. Morris Greystock, the controller of the Merseyside plant had notice a decline in stock price in from 250 pence per share in 2006 to 180 pence per share in 2007 and knew he had to do something. Facing pressure from the investors and wanting to increase production efficiency, he decided to renovate the Merseyside plant so Victoria Chemicals can lift itself back to where it once was and continue to be one of the major competitor’s in the worldwide chemical industry. After taking all the costs and benefits into consideration, Greystock put together his own analysis in which he based it on four difference components; Earning per Share, Payback Period, Net Present Value, and Internal rate of return. Soon after many people looked at his analysis and had several questions and suggestions to give to Greystock. We will see soon enough that Greystock’s Analysis had many flaws that needed to be fixed and how it really should have been done.

II. Victoria Chemicals and it’s Capital Expenditures

Victoria Chemicals incorporated four different types of methods to determine its capital budgeting proposed projects. They include Earnings per Share (EPS), Pay Back Period (PBP), NPV, and the Internal Rate of Return (IRR). Of the four methods, the two favorable to use for evaluation would be NPV and IRR while the EPS and PBP would be less favorable to use because of its evaluation process. Using NPV is a good method to use to evaluate the project because it takes in account for all the costs relevant to the project and includes all the cash flow of the project as seen on exhibit 1. We would also include the IRR because of the beneficial picture that it creates. However, there can be a complication if two scenarios arise. The first complication can be realized when there is a negative Cash Flow other than the initial year of the implementation of the project and dealing with a mutually exclusive project. Neither one of these scenarios occur for the proposed Victoria Chemicals project. The pay back period and EPS are not used in the final determination of accepting the project because of their shortfalls. When using EPS to evaluate a project it will be more biased towards shorter term project. This is because EPS focuses on the current cash flows instead of the direct cash flows. The reason why Pay Back Period isn’t a determining factor in accepting a project is because it doesn’t take into consideration the time value of money and also ignores any Cash Flow that occurs after the payback period has been reached.

III. Transportation Division Dispute

The Transport Division suggestion is that the tank car purchases should be included in the initial outlay because the increased output will exhaust the capacity of the current tank cars and thus will make the company purchase them in year 2010 instead of 2012. This shift in time will alter the timing of the cash flows and will have a direct affect on the incremental depreciation as seen on exhibit 1. While Greystock argues that it shouldn’t be included because it will initially use the excess capacity of the Transport Division.

IV. Facing Cannibalization

The director of sales suggest that if the project is accepted then it means they will have to shift capacity away from the Rotterdam plant and towards in Merseyside in order to compensate for the increased output volume. This process of shifting resources would result in an internal cannibalization. The director of sales also warns of an oversupply in the market due to stiff competition and the...
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