Case #22 Victoria Chemicals

Synopsis and Objectives go/no-go decision 1. The identification of relevant cash flows; in particular, the treatment of: a. sunk costs b. cash flows obtained by cannibalizing another activity within the firm c. exploitation of excess transportation capacity d. corporate overhead allocations e. cash flows of unrelated projects f. inflation. 2. The critical assessment of a capital-investment evaluation system. 3. The treatment of conflicts of interest and other ethical dilemmas that may arise in investment decisions.

Suggested Questions 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, the Director of Sales, her assistant plant manager, and the analyst from the Treasury Staff? 2. How attractive is the Merseyside project? By what criteria? 3. Should Morris continue to promote the project for funding?

Exhibit 1 VICTORIA CHEMICALS Excerpts from Morriss Expenditure Proposal Memo Regarding the Merseyside Project

VICTORIA CHEMICALS
To: From: Subject: James Fawn Lucy Morris and Frank Greystock Capital Expenditure Proposal: Polypropylene Line Enhancements (Merseyside)

This memo summarizes the rationale and financial impact of capital improvements to the polypropylene line at Merseyside. The investment requested is 12 million. Strategic and operating benefits were summarized in our previous memo to you. We have made, however, some changes to our investment analyses, which appear below. Two discounted cash flow analyses accompany this memo. Part A contains an adjustment for possible business erosion at Rotterdam, while part B does not make that adjustment. The results are: Erosion 8.8 m 22.3% No Erosion 17.1 m 31.0%

NPV IRR

The costs of the engineering study and corporate overhead allocation have been excluded from the analysis, per discussions with John Camperdown. Tank-car expenditure occurs earlier in time, and changes in depreciation tax shields are reflected herein. The discount rate used is 10%, and the cash flows used are nominal, rather than real cash flows. We would be happy to respond to any remaining questions you or the board may have.