TN20 Diamond Chemicals PLC A And B

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Diamond Chemicals PLC (A) and (B) Teaching Note

Synopsis and Objectives

These two cases present the capital investment decisions under consideration by executives of a large chemicals firm in January 2001. The A case (case 20) presents a go/no-go project evaluation regarding improvements to a polypropylene production plant. The B case (case 21) reviews the same project but from one level higher, where the executive faces an either/or investment decision between two mutually exclusive projects. The objective of the two cases is to expose students to a wide range of capital budgeting issues:

A case: go/no-go decision

1. The identification of relevant cash flows; in particular, the treatment of:
a. sunk costs
b. cash flows
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Here the class must grapple with the potential charge for the use of excess capacity in another division.
3. What is the director of sales’ suggestion? Does it have any merit?
The focus here should be the cannibalization issue.

4. Why did the assistant plant manager offer his suggested change? Does it have any merit?
This question raises the issue of extraneous cash flows.
5. What did the analyst from the Treasury Staff mean by his comment about inflation? Do you agree with it?
At this stage of the discussion, students should review the need for internally consistent assumptions about inflation.
6. How should Greystock modify his DCF analysis?
This question turns to a summary of the adjustments needed to produce an acceptable DCF analysis.
7. What is the Merseyside project worth to Diamond Chemicals?
Producing, in class, a revised DCF analysis helps to provide students with closure on the discussion.

Plan for the B case

1. Do you endorse Eustace’s analysis of the project at Rotterdam? How would you improve on it?
This open-ended question is intended to stimulate a critique of Eustace’s analysis. The key point of objection is her inclusion of the right-of-way in the analysis. A brief discussion should establish that the option of the right-of-way should be exercised regardless of whether the project at the Rotterdam plant is undertaken. Therefore, the cash flows associated with the right-of-way should be separated from the rest of the Rotterdam

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