Diamond Chemicals is considering two mutually exclusive projects, the Merseyside project and the Rotterdam project, for the production of polypropylene
When considering the Merseyside project, senior-management wants a positive impact on earnings per share. The addition to earnings per share was £28,800 with an average addition of £2,000 per year2. Calculated with erosion, the addition to earnings per share was £18,800 with an average addition of £1,100 per year2. The payback period for the project was 3.10 years, when considering the erosion of Rotterdam, this would increase to 3.46 years2. The net present value of Merseyside is £15.61 million and when considering erosion, the net present …show more content…
The ICG Sales and Marketing Department are concerned about the possibility of erosion. If the Merseyside project is accepted, its new net present value would be £15.612. Taking into account worst case scenario, the erosion effects on Rotterdam would lower net present value to £11.372. Conversely, if we would choose to accept the Rotterdam project, its net present value would be -£3.244. Taking into account worst case scenario, the erosion effects on Merseyside would lower net present value to -£6.614.
Concerns of the Assistant Plant Manager:
Griffin Tewitt had proposed a renovation of the ethylene propylene copolymer (EPC) production line. EPC is a variety of synthetic rubber which is sold in bulk to European tire manufacturers. The initial outlay of the project would be £1 million and will improve cash flows by £25,000 ad infinitum. This project, however, produces a net present value of -£750,000. Because of the negative net present value, we chose not to implement this project.
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Concerns of the Treasury Staff:
The Treasury Staff brought up a concern of using a 7% target rate of return. They thought that with a 3% inflation rate, the 10% hurdle rate should be adjusted down to 7%. However, we found that the 10% hurdle rate was in nominal terms, which corresponded with our nominal cash flows. If we would have used the 7% rate, we would have overestimated the net