Finance and Terminal Value
Why are the Merseyside and Rotterdam projects mutually exclusive? They are mutually exclusive because it would not make sense to invest in both projects. It has to be one or the other project, because an increase in out of 14% it not necessary in current market conditions. They are facing intense competition and in a recession. If the increase output to 14% they will not be able to sell it all without dropping prices and hurting already bad margins. Another reason is that an investment into the Rotterdam project seems like it is irreversible due to the extensive modifications needed for the plant and the pipeline.
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So if the plans do not work out they cannot back out of it and try the Merseyside project. 2. How do the two projects compare on the basis of Victoria Chemicals’ investment criteria? What might account for the differences in rankings? Investment Criteria – Unmodified RequiredMerseysideRotterdam EPS ImpactPostiveGBP . 022GBP . 049 Payback10%24. 30%18% Assuming the unmodified basic projections in the project proposals we can see that the Rotterdam project has a clear lead in almost every aspect except payback period. The payback period on the Rotterdam project does not meet the criteria.
Difference might be that the Rotterdam requires significant invest spread over a period of time. The pipeline is a significant investment and upgrade for the plant. The NPV and IRR seem to relay heavily on the terminal value of the pipeline. The Japanese technology might be more efficient in the long run than the upgrades. The Merseyside project is much simpler and costs aren’t spread over 3 years. 3. Is Elizabeth Eustace’s treatment of the right-of-way correct in her spreadsheet analysis? I don’t think it is at all correct to assume the terminal value will be $40 million in 15 years.
Projecting 15 years out is a very long time to make such an assumption even with a consultant forecast. A lot can happen in 15 years, there could be another a bubble crash and the pipeline could be worth nothing or it could be in a bubble and it would be worth double. Because there isn’t enough information about the demographics of the area, seems like the right-of-way of the pipeline is such a specialized product and that it would be very hard to value. 4. Is it possible to quantify the value of potentially adding the Japanese technology to the Merseyside project?
Discuss what the economic impact is from this investment flexibility. It is possible to quantify the value of being able to add in the technology at a later date. Though it might be hard to give an exact number, but since the Merseyside project has a much faster payback period and more free cash flow early on, this is a value added to the Merseyside project. The impact of this flexibility is that it makes this project much more attractive than the Rotterdam where you cannot turn back once it has been started. 5.
Which project should James Fawn propose the CEO and the Board? Since the Rotterdam project does not meet one of the investment criteria, it should not be considered. This is not the only reason though; the Rotterdam project is much too dependent on the terminal value of the right-a-away. As it is mentioned in the report the company is a chemicals company, it what they do. To have such a large part of the project into something they do not do doesn’t make very much sense. Another reason is that Merseyside provides a lot more flexibility and is a lot less risky.