FINC421 – Case Study in Corporate Finance
Diamond Chemicals plc. : The Merseyside Project
The goal of this report is to analyze and evaluate the capital budgeting decision of Ms. Morris and suggestion to the senior management of Diamond Chemicals PLC if sufficient capital should be allocated for the proposed £12 million expenditure to modernize and rationalize the polypropylene production line at the Merseyside Plant. The project has been proposed to improve the product output of Diamond Chemicals’ Merseyside factory. However, recently, different departments have mentioned problems such as capital expenditure, marketing cannibalization, discount rate etc. Diamond Chemicals needs to take all these suggestions into consideration. Based on that they have to decide if they should carry out this project or not. Assumptions:
Preliminary engineering costs:
We have decided not to include this figure because we assume that its cost has already been paid out. Therefore its investment will not be necessary and if the project does not go through that money will not be reusable.
The treasury staff is partly wrong. He says we should use a discount rate of 7%. This would be true if the discount rate was the real interest rate, however for the discounting we are supposed to use the normal rate. Since we have to add 3% inflation rate in our model. Our discount rate becomes: Nominal = Real + inflation Nominal discount rate = 7%+3% = 10%
So our discount rate stays at 10% and our inflation rate goes to 3%.
Plant assistant manager:
We should add £1M to the initial cost of the project as well as an additional 25,000£ in every cash flow starting from the first year. This project seems to be important on the long term but the impacts on the short term must be studied in order to identify if this project is interesting on the short/medium term.
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