Victoria Chemicals Case Analysis

Victoria Chemicals’ Merseyside, located in England, is a leading producer of polypropylene.  The company is in the process of evaluating a facilities upgrade project, requiring a capital investment of GBP12 million.   The existing facility, which was built in 1967, is one of the oldest plants in the industry.  Due to its age, along with deferred maintenance that was not completed, the production cost per ton of 1.09, is the 4th highest in comparison to the 5 largest competitors in the market.  The investment would consist of renovating the production line, which would entail replacement of existing assets that have been fully depreciated.    In order to receive senior management’s approval, the project must pass a series of performance “hurdles” based on the project type.  The following will provide feedback to each shareholders concerns and detail why this project should still be recommended for funding.

Response to the Director of sales: With the implementation of the project, Merseyside will cannibalize the plant in Rotterdam. Merseyside will have a higher efficiency and lower production costs. Since both plants have the same production cost index, the cannibalism cash flow shift will be shown as the output. When the output is at 0%, there will be no incremental growth and shifts from Rotterdam to Merseyside, the NPV is 7.8 and the IRR is 19.5%. Because of those reasons, we did a sensitivity analysis for the output and the discount rate (see Table 1 and 2).

Response to Transport Division: Since the Transportation Division is not operating at full capacity, it can accommodate the expected increase in the production. The Transportation Controller suggested the need for new rolling stock at a cost of GBP 2M to support the anticipated growth of the firm. The cost of the new tank cars must be included in the DCF project analysis. We added GBP 2M in 2010 and took away 2M in 2012 in the capital expenditures.

Response to the Assistant plant manager: The Asst. Manager proposed a renovation of the EPC line, which will cost GBP 1 Million.  The renovation would give Victoria Chemicals the lowest EPC cost base in the world and improve cash flows by GBP25,000 ad infinitum.  The NPV for this project is -GBP750,000.  The request should be rejected and treated as a separate project, as it would diminish the attractiveness of the overall project by lowering its positive NPV.

Response to Treasury Staff: The 10% hurdle rate excludes inflation because it’s part of the latest edition of Victoria Chemical’s capital-budgeting manual. However, as prescribed by Andrew Gowan from the treasure staff, we should include inflation in the calculation to evaluate the project. The treasure staff expects long-term 3% yearly inflation.

General Cash Flow Considerations:  As stated in the corporate policy manual, “all new capital projects should reflect an annual pretax charge amounting to 3.5% of the value of the initial investment.”  Only overhead costs which are determined to be directly related to accepting the PL project should be included.   Overhead of 3.5% (or 420,000 GBP) should be included in projection from initial 12 million GBP allocation.