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.