EPPM3644 CORPORATE FINANCE AND RESTRUCTURING

SEMESTER 1 ACADEMIC SESSION 2013/2014

CASE STUDY REPORT: Victoria Chemicals Plc (B): The Merseyside and Rotterdam Projects

WOO SI KUAN BOO KIANG MING CHAN KOR YAN ONG YI LING SOO CHEE CHUAN

A135986 A136032 A136598 A136608 A136629

1. Case Overview Victoria Chemicals is a leading producer of polypropylene, a polymer used in a wide variety of products. Its executive vice president James Fawn was presented with two projects to improve polypropylene output for Victoria Chemicals: one for its Merseyside plant, the other for the plant in Rotterdam. Each project had the potential for increasing production by 7%. Since a combined increase of 14% was unwarranted, James could only support one of the proposed projects. Victoria Chemicals used four criteria in the evaluation of project proposals: net present value, internal rate of return, payback period, and growth in earnings per share. Regarding the approach of the two managers in proposing their projects, Eustace (Rotterdam)s approach was fairly aggressive compared to Morris (Merseyside). First, Eustaces project proposal focuses on estimating the future value of land rights, far outside the scope of the firms core business. Second, she argues as if there were no other option but to move ahead with the new technology, and goes as far as to insult the Merseyside proposal. Morris, however, is more restrained in her proposition, not disregarding the new technology out of hand. Rather, she insists that the company wait and see if the technology would prove itself over the coming years. It appears that Morris more reserved attitude likely garnered more support for her proposal. Eustace provides a much more thorough report, however, leading some group members to argue that her project would be more attractive, as there is more supporting data and scenario analysis, resulting in fewer ambiguities. However, other members counter that Morris says in three pages what Eustace does in ninety, arguing that simply having an overwhelming amount of data does not make the Rotterdam project more attractive.

2. Symptoms and Problems

Symptom 1 They have two mutually exclusive capital-expenditure projects to be reviewed by the firm. The first project is to enhancing the existing facilities and the production process of Merseyside plant. The second project is purchase pipeline and extended it to Rotterdam plant. Although this two projects can increase the output of polypropylene but they can choose only one project to be implement. Problem Which project should Victoria Chemicals choose?

Symptom 2 Victoria Chemical used four criteria to evaluate the two projects. The four criteria is net present value (NPV) computed at the appropriate cost of capital, internal rate of return (IRR), payback period and growth in earning per share. After they did the analysis, all four of the criteria that used to evaluate both project showed different preferences on each projects. Problem Which of the criteria should be viewed as the most important and useful in choosing the project?

Symptom

Problem

1. To enhancing the existing facilities and the Which project should Victoria Chemicals production process of Merseyside plant or choose? purchase pipeline and extended it to Rotterdam plant. 2. All four of the criteria that used to Which of the criteria should be viewed as evaluate both project showed different the most important and useful in choosing preferences on each projects: the project? - net present value (NPV) computed at the appropriate cost of capital - internal rate of return (IRR) - payback period - growth in earning per share

3. Data Analysis The Merseyside project showed an NPV of 10.45m compared to Rotterdams 15.48m. The IRRs were 24% and 18% for Merseyside and Rotterdam, respectively. Merseyside would take 3.78 years to pay back the initial investment, and Rotterdam would take 7.95 years. Growth in earnings per share was 0.022 for Merseyside and 0.048 for Rotterdam. The differences in rankings were due to a substantial difference in the respective projects initial outlays and expected cash flows. The Merseyside project had a higher IRR and a much lower payback period. Rotterdam had a higher NPV by almost half a million pounds, and a larger growth in EPS. 4. Solutions There is a conflict existing between these two mutually exclusive projects. Therefore, we will choose the best project based on the best criterion, which is NPV because NPV assumes reinvestment at the cost of capital and that is generally the best assumption. Hence, the Rotterdam project should be chosen.

5. Alternative Solutions

We believe the discount rate should be adjusted. We used the 7% discount rate which was deemed more accurate. We also accounted for a 3% inflation premium.

6. Implementation of Alternatives The expected Net Present value of the Rotterdam project using the revised discount rate and premium is GBP 27.79million. NPV gives explicit consideration to the time value of money and is a good method to evaluate the project because it assesses all the cost involved. When the NPV of the project is greater than zero, then the firm can believe that this is an acceptable project. This new NPV shows that the project is a great investment. If they were to account for full erosion of Rotterdams business volume, there would still be a positive NPV for Merseyside and above the hurdle rate. The new IRR is 10.5% and this holds the project at an 3.5% higher rate than minimally expected for a project. This IRR represents the project in a positive light.

7. Conclusion James Fawn did have an extremely difficult decision to make. Although the Merseyside project passed all four criteria for further consideration, it was NPV

which ultimately prevailed as the superior criterion. Therefore, Fawn should select the Eustace proposal.