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    Jia Le
    Lucy Morris should ask Frank Greystock to make the following changes to his DCF analysis: 1) Exclude the $2 million cost for new rolling stock from the Transport Division as it was not an actual expenditure and belongs to a separate division. 2) Consider only the incremental sales from the Merseyside project and similar incremental sales at Rotterdam to address the Director of Sales' concerns about cannibalization. 3) Use a real discount rate of 7% instead of a nominal rate of 10% to properly account for inflation since the cash flows are in real terms.

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    Part 1

    Uploaded by

    Jia Le
    340 views2 pages
    Lucy Morris should ask Frank Greystock to make the following changes to his DCF analysis: 1) Exclude the $2 million cost for new rolling stock from the Transport Division as it was not an actual expenditure and belongs to a separate division. 2) Consider only the incremental sales from the Merseyside project and similar incremental sales at Rotterdam to address the Director of Sales' concerns about cannibalization. 3) Use a real discount rate of 7% instead of a nominal rate of 10% to properly account for inflation since the cash flows are in real terms.

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    Lucy Morris should ask Frank Greystock to make the following changes to his DCF analysis: 1) Exclude the $2 million cost for new rolling stock from the Transport Division as it was not an actual expenditure and belongs to a separate division. 2) Consider only the incremental sales from the Merseyside project and similar incremental sales at Rotterdam to address the Director of Sales' concerns about cannibalization. 3) Use a real discount rate of 7% instead of a nominal rate of 10% to properly account for inflation since the cash flows are in real terms.

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    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    340 views2 pages

    Part 1

    Uploaded by

    Jia Le
    Lucy Morris should ask Frank Greystock to make the following changes to his DCF analysis: 1) Exclude the $2 million cost for new rolling stock from the Transport Division as it was not an actual expenditure and belongs to a separate division. 2) Consider only the incremental sales from the Merseyside project and similar incremental sales at Rotterdam to address the Director of Sales' concerns about cannibalization. 3) Use a real discount rate of 7% instead of a nominal rate of 10% to properly account for inflation since the cash flows are in real terms.

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    of 2

    1.

    What changes, if any, should Lucy Morris ask Frank Greystock to make in his
    discounted cash flow (DCF) analysis? Why? What should Morris be prepared to say
    to the Transport Division, Director of Sales, her assistant plant manager and the
    analyst from the Treasury Staff?

    Concerns of Transport Division

    Lucy Morris should not ask Frank Greystock to include the $2 million cost of buying rolling
    in the discounted cash flow (DCF) analysis. Firstly, there was no actual expenditure was even
    made for the transport division as it was just preparing for future expenditure as according to
    the journal (Appendix 1) stated that the transport sector can draw on this excess capacity
    although doing so will accelerate demand for new rolling stock between 2012 to 2010 to
    support the company’s expected growth in other million. Nevertheless, the expenditure also
    considered as part of the Transport Division and they do not belong to the Intermediate
    Chemicals Group thus they should bear the cost themselves. This is because there is a policy
    that every division’s expenditure is independent of other. In addition, the transport division and
    the Intermediate Chemicals Group also report separately to the vice presidents, who then
    reported to the chairman and chief executive officer of the company. The executive vice
    presidents who receives an annual bonus based on the performance of their respective
    departments.

    Concerns of Sales and Marketing Department

    The director of sales had reasonable concerns regarding to the cannibalization of the sales of
    the Rotterdam plant. As Greystock points out, Victoria Chemicals should not add extra fees to
    cost-cutting projects. As production increases, lower costs will take market share away from
    competitors rather than having a competitive effect because polypropylene is priced as a
    commodity. Although Merseyside may outperform Rotterdam, this should be a sign that same
    capital projects are being implemented in Rotterdam to improve its efficiency and throughput
    to achieve the same cost competitiveness. Hence, Lucy Morris should ask Greystock to
    consider only the incremental sales in its DCF analysis not only for the Merseyside project but
    also similar sales at Rotterdam power station in order to give more accurate forecast and
    address the issue.
    Concerns of Assistant Plant Manager

    The assistant plant manager proposal to renovate the EPC production line is part of the overall
    proposal which is based on strategic advantages and achieves the lowest EPC cost basis. Even
    if the NPV is negative, the EPC production line is still expected to achieve higher sales and
    prices after the recession ends. This can be explained by the proposed project is an "engineering
    efficiency" project which is the same as the capital plan proposed by Morris with a negative
    NPV of -0.75 million pounds and a net NPV of positive capital of 16.65 million pounds. On
    the flip side, we believe that this should not be included in the proposal because the strong
    personal opportunities of the relevant personnel lead to too high expectations for the growth
    prospects of EPC and the negative NPV will also erode the overall NPV of the renovation
    proposal.

    Concerns of Treasury Staff

    In the original analysis, the inflation rate was assumed to be 0%. So, the treasury staff raised
    an issue that this is the nominal interest rate and should be used because there is a 3% inflation
    factor in the DCF analysis but the cash flow in the analysis is real and must be nominal.
    Therefore, the nominal discount rate (10%) used in Greystock's analysis should be adjusted to
    the inflation rate (3%), and the real interest rate of 7% should be used to discount the project's
    incremental cash flow. As a result of this method, both NPV and IRR are reduced accordingly.

    Other Concerns

    Besides that, another problem is that the DCF analysis takes preliminary engineering costs as
    expenditures and it should not be included in the project DCF because it is a sunk cost. In
    addition, we believe that depreciation used in DCF analysis should not accelerate depreciation.
    This is because the company proposes to use a double declining balance method for the project
    but this radical depreciation is conducive to tax savings and a more cautious measure is a
    straight-line method that fully depreciates the expenditure and has a more accurate outlook. As
    a result, this will give senior managers more peace of mind that they will not be tricked into
    accepting a project for receiving tax benefits.

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