Chemical Diamond

2376 Words Nov 6th, 2014 10 Pages
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Diamond Chemicals: The Merseyside and Rotterdam Projects Valuation and Recommendation |

Table of Contents
Executive Summary2
Problem Statement & Issues3
Analysis of Merseyside & Rotterdam3
The Merseyside Proposal & Analysis3
Static NPV4
Option to Switch to Japanese or German Technology4
The Rotterdam Proposal & Analysis5
Static NPV5
Option to Switch to German Technology5
Qualitative Considerations6
Recommendation7
Appendix I – Black-Scholes Model for Japanese Option8
Appendix II – Merseyside Margrabe Model for German Option8
Appendix III – Merseyside Assumptions9
Appendix IV – Merseyside Discounted Cash Flow Analysis9
Appendix V – Merseyside Depreciation Schedule10
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The prices of the deferral option and option to switch are zero and £0.11 million respectively. The total NPV of the upgrade is £8.32 million. The incremental earnings per share of the upgrade is £ 0.0172, the payback period is 4.23 years, and the internal rate of return is 24.3%.
The upgrade of the Rotterdam plant involves implementing the Japanese technology and requires a capital expenditure of £8.0 million with £3.5 million spent today, £2.0 million on year one, £1.0 million on year two and £1.0 million on year three. This will also increase polypropylene output by 7% from current levels at a rate of 2.0% per year. In addition, gross margin will improve by 0.8% per year from 11.5% to 16.0%. After auditing the financial models, it is concluded that the static net present value of the upgrade is -£6.35 million using a discount rate of 10% and an expected inflation rate of 3% annually. The Rotterdam upgrade contains an option to switch to the speculated German technology being available in five years. The current value of the option is zero as it is deeply out-of-the-money. The total net present value of the upgrade is -£6.35 million. The incremental earnings per share of the upgrade is £ 0.0013, the payback period is 14.13 years, and the internal rate of return is 18.7%.
The Merseyside project clearly provides a superior return to the Rotterdam project based on the profit, cash flow and payback criteria. In addition, the positive net

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