Victoria Chemicals Case

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The NPV for Rotterdam was also calculated when considering erosion. Erosion can include any negative impact on a company’s associated assets or funds. In this case, the investment into Rotterdam will lead to an erosion in the output of polypropylene at the Merseyside, Liverpool plant. This reduction in output will affect the overall sales for Victoria Chemicals and their overall projected Free Cash Flows. This reduction in sales was integrated into our Discounted Free Cash Flows model. The worse case scenario was calculated and it revealed a NPV of £12.5 million pounds and a IRR of 16.5%. The NPV is still positive which is a great sign, however it is £3 million pounds less. Additionally, the IRR is still in excess of the targeted rate of return of 10%. Furthers more the real target rate is 7%, which takes into consideration an inflation rate of 3%. Based on these criteria the project still seems like a viable investment. Erosions did decrease the projected cash flows but did not have a devastating effect on the project.

Each alternative will have different calculations as they factor in different macroeconomics factors. For example, inflation, the state of the economy and depreciation.

Merseyside Liverpool -

The Merseyside, Liverpool proposal also project a 7% increase in Victoria Chemicals production of polypropylene. In formulating the Merseyside model we decided to input strategic factors into our model to represent a more realistic estimation of our Future Cash Flows. New depreciation of Tank cars, erosion, inflation and a new discount rate of 7% were included. The NPV was then calculated to be 10.49%. The investment was proposed to cost 12 million pounds, which includes the relocation and modernization of the plant. Merseyside projects its energy savings 10 years ahead. The plan to refurbish the polymerization tank to achieve higher pressures and a greater output- then the renovation of the compounding plant to increase extrusion and obtain energy savings. The plant did not believe that the customer losses would be permanent because of the stop of production.

The Merseyside project showed an NPV of £10.45m compared to Rotterdam’s £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.

Section IV – Final Recommendations

James Fawn will have to decide which one of these two capital expenditure projects will bring the most value to Victoria Chemicals. As mentioned before, the two projects are mutually exclusive and it only makes sense to take on one project. The project will have to be chosen based on the best criterion. Our Analyst have come to a consensus that Net Present Value is the best criterion there is in evaluation capital expenditure projects. The Net Present Value for Rotterdam, even with factoring erosion was still significantly higher than the NPV for Merseyside, Liverpool. As analyst we can confidently recommend that James Fawn select alternative 1 - the Rotterdam capital expenditure project over the Merseyside, Liverpool project.

Section V - Appendix

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