Nan Shao Case_22 Report: Victoria plc

Introduction: Victoria Chemicals, a leading producer of polypropylene, was a major competitor in the worldwide chemicals industry. Victoria Chemicals had two divisions: Intermediate Chemicals Group (ICG) and Transport Division. The company produced polypropylene at Merseyside and in Rotterdam, Holland. The two plants were of identical scale, age, and design. Although Victoria Chemicals had the largest annual output in this industry, its production was infected. Compared with its competitors, Victoria Chemicals had relatively higher production cost. Moreover, its financial performance also cannot be satisfied by its investors since its earnings had fallen to 180 pence/share at the end of 2007 from around 250 pence/share at the end of 2006. Lucy Morris, the new plant manager of Victoria Chemicals Merseyside Works in Liverpool, wanted to make some change because the current production have become outdated and fallen behind the industry standards. The current process is more labor intensive and thus more expensive than other competitors in the industry. Morris has proposed a GBP12 million project to renovate the plant. The project includes: 1. relocating and modernizing tank-car unloading areas, which would enable the process flow to be streamlined; 2. refurbishing the polymerization tank to achieve higher pressures and thus greater throughput; and 3. renovating the compounding plant to increase extrusion throughput and obtain energy savings. If the company take this project it will achieve 7% greater manufacturing throughput, 1% gross margins increase (from 11.5% to 12.5%), and energy savings would be realized of 1.25% in years 1-5 and 0.8% in years 6-10. After this ten-year period the energy efficiency of the plant would revert back to current levels. So, should Victoria Chemicals invest this project? Analysis: When senior management evaluated a project, it must meet at least three out of four performance hurdles, which are: (1). Impact on earnings per share: the contribution to net income from contemplated projects had to be positive. (2). Payback period: less than six years.

Nan Shao Case_22 Report: Victoria plc

(3). Discounted cash flow: NPV had to be positive. (4). IRR: IRR greater than 10%. As Greystocks analysis, if we assume that the output kept 267,500 tons each year for 15 years in row, and the price of polypropylene was GBP675 per ton, then the net present value of this project was 10.45 millions, IRR was 24%, and the payback period was 3.8 years (see table 1). Based on these numbers the management should accept this project. However, there are some concerns about Greystocks analysis. First, this project increases throughput, so the Transport Division would have to increase its allocation of tank cars to Merseyside. By doing this, the Transport Division needed to purchase new rolling stock, and the purchase was estimated to be GBP2 million in 2010 (it would have a depreciable life of 10 years), but Greystock did not consider this cash outflow that was directly related to the new project. Secondly, as the Voctoria Chemicals Treasury staff concerned, cash flows and discount rate needed to be consistent in their assumptions about inflation. They expected a long-term inflation of 3% per year, so Voctoria Chemicals real target rate of return should be 7% instead of 10%. Based on these two concerns, we adjust year 0 cash flows to -14 million, the discount rate to 7%, the inflation rate to 3%, and we keep other assumptions stable. We have the adjusted NPV is 17.73 million, IRR is 24%, and the payback period is 4.1 years (see table 2). Moreover, the average annual earnings per share contribution of the project over its entire economic life is GBP0.037 (using 92,891,240 shares outstanding at FYE2007). Summary: This project perfectly meets the four performance criteria, so we recommend that the management of Voctoria Chemicals take this investment. In addition, we also recommend that the management should reject the ethylene-propylene-copolymer rubber (EPC) project. First, EPC project has negative NPV. Secondly, EPC had been only marginally profitable to Victoria Chemicals. More importantly, the new technology product, synthetic-rubber compounds, will dominate EPC in the future, so the management should not only reject EPC project, but also divest this department, and try to develop new technology products and find new opportunities in this industry.

Nan Shao Case_22 Report: Victoria plc

Table1 rate=10% Cash Flow -12 1.27 3.92 3.86 3.81 3.77 3.08 3.07 3.05 3.02 3 2.05 2.09 2.09 2.09 2.09

Table2 rate=7% Cash Flow -14 1.62 4.07 4.11 4.17 4.24 3.56 3.66 3.74 3.86 3.96 2.74 2.88 2.98 3.07 3.17

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Paybac k= 3.8 year

PV -12 1.15 3.24 2.90 2.60 2.34 1.74 1.58 1.42 1.28 1.16 0.72 0.67 0.61 0.55 0.50

Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Paybac k= 4.1 year

PV -14 1.51 3.55 3.35 3.18 3.02 2.37 2.28 2.18 2.10 2.01 1.30 1.28 1.24 1.19 1.15

NPV= 10.45

IRR= 24%

NPV= 17.73

IRR= 24%