This project is based on cash flows calculations of Diamond Chemicals Plc. We have determined its IRR and NPV considering various recommendadtions.

1. Diamond Chemicals plc (A):
The Merseyside Project
Submitted by:
Section 1 Group 5

2. Introduction
 Summary of the Case:
Major competitor in worldwide chemicals industry &
a leading producer of polypropylene
Morris (plant manager at Diamond Chemicals) is recommending a 9
million project;
- Renovate and rationalize a production line at merseyside
- To make up for deferred maintenance and increase production efficiency
Several objectives to the project have been raised at the corporate, and
the initial analysis from Frank greystock(Controller of Diamond Chemicals
plant) contains errors that needs to be fixed.

3. Regarding the Case
 The project shows a highly positive NPV and meets all the
investments criteria, there are some issues:
i. The production line is being to shut down for 45 days during
which customers would buy from competitors.
ii. The project requires the parent company’s Transport Division
to invest 2 mn pounds which the controller refuses to add in
her own project’s outlay.
iii. The marketing department is skeptical about sales figures due
to the ongoing recession.
iv. The assistant plant manager wants the controller to include
an EPC project as a part of the overall project.
v. A Treasury analyst says the discount rate used is incorrect.
Additionally, the treatment of engineering costs is incorrect.

4. Recommended Adjustments
• Annual Pretax charge for overhead
• Engineering Sunk costs
• Cash flow and discount rate consistency
• Transportation Investment
• Lost Sales Impact

5. Recommendation 1
Annual Pretax charge for overhead
 Corporate manual states overhead costs be reflected at 3.5%
rate
 This project is expected to reduce overhead costs and should
not be required to charge an annual pretax
 Before removing Pretax charge :
NPV: 9
IRR : 25.9%
 After removing Pretax charge:
NPV: 10.67
IRR : 28.5%

6. Recommendation 2
Sunk costs involved in Engineering
 0.5 million pounds for renovation efficiency is included in the
analysis
 Sunk costs are retrospective costs that have already been
spent and cannot be recovered according to the with-
without principle, not relevant to the present decisions.
 Previous:
NPV: 9
IRR : 25.9%
 After removing Sunk costs:
NPV: 9.31
IRR : 26.8%

7. Recommendation 3
Inflation : Cash Flow and discount rate consistency
 The discount rate currently used in evaluating the project is
10%. However, it’s the nominal rate but the cash flows are
real. Hence, the discount rate used should be adjusted for
inflation, which is 3%.
 At 10% discount rate:
NPV: 9
IRR : 25.9%
 At 7% discount rate:
NPV: 12.32
IRR : 25.9%

8. • 3% Inflation should be considered for forecast
and take discount rate as 10%.
• Caluclate : New Sales, Old Sales, Depreciation
–wud not be recalculated.
• Gross Profit – olld , new , incremental will be
recalcualted.
• WIP – recalucllatd.Inventory will b
recalculated.
• CAPEX – No recalucation

9. • Tax will not be recalculated.
• Transportation Division: Transport div. is a cost
center. A dept which supports other depts and
incurs costs for providing such support.
• So, transportation cost for the entire project
has to be incurred and taken into account.

10. Recommendation 4
Addition of Transportation Investment
 2 million pounds for purchasing new rolling stock to support
anticipated future growth was not included in the DCF
analysis.
 Cost should be considered a cash outflow and expense.
 Before adding Transportation Investment :
NPV: 9
IRR : 25.9%
 After adding Transportation Investment:
NPV: 5.55
IRR : 18.4%

11. Recommendation 5
Lost Sales Impact
 Greystock DCF analysis concludes that all customers will
return within one year.
 Conservative approach concludes not all customers will
return so quickly and this will impact sales and should be
included in the analysis.
 Potential impact includes the overall state of the economy
and improving competitor frequencies.
 RECOMMNDATION : Include customer loses

12. Summary of Adjustments to NPV
Following is the impact of the adjustments to the project:
With No Adjustments:
NPV: 9
IRR : 25.9%
With Adjustments:
NPV: 14.66
IRR : 29.4%

13. Conclusion
The project should be undertaken due to the
following reasons:
– NPV and IRR increases as the cumulative effect of these
adjustments.
– Project meets all the investment criteria and adds to the
shareholder value.
– This will increase efficiency and would result in gain in the
long run for the organization.
– With the new technology the organization is likely to benefit
from the returns to scale as well.