Diamond Chemicals Case Study
Diamond Chemicals can modify their evaluation methods by including the Retail Prices Index (RPI) measure of the use of the final products of polypropylene. This will be necessary to enable the company estimate the inflation from the perspective of the customer and from the perspective of the business, as well. This will change the associating costs as estimate by Morris, and this will have an impact on the estimated budget because more money will have to be secured to take into consideration the inflation rates.
The evaluation methods of Diamond Chemicals can also be modified by including other detailed financial statements from both their branches in Liverpool and Rotterdam. In addition to the statement of cash flows, an analysis of the balance sheet will be important particularly in revealing the real estimate of the depreciation of different assets as well as the liabilities of the company. An income statement will help to provide more comprehensive information about the tax obligations of the firms as well as their profitability, and these statements will be important to compare to the cash flows (Grinin, Korotayev & Tausch, 2016). Without these additional financial statements in the evaluation process, it will not be possible to make an informed decision that will directly result in benefits for Diamond Chemicals.
The evaluation methods on the use of funds can be modified to include a risk assessment that will eventually result in more funds being needed. The methods employed by Diamond Chemicals do not consider any risks associated with misappropriation or poor use of funds. In addition to the fact that inflation considerations have not been made, the techniques for analyzing the use of funds have to be modified. This will allow Morris to have a much clearer forecast of the direction that the company will take if she proceeds with the proposed capital program in Merseyside. [Click Essay Writer to order your essay]
Is the Merseyside Project Worthwhile?
The Merseyside Project is worthwhile to Diamond Chemicals because it has enabled the company to establish a foothold in Liverpool. Of the major competitors in the industry, Diamond Chemicals has penetrated and operated in the Liverpool market since 1967, earning the trust of a sizeable pool of clients (Bruner, 2001). Upgrading production methods and boosting its financial capabilities will be a worthwhile venture because it will allow the company to continue on a path of successful growth.
The Merseyside and Rotterdam projects compare equally on a financial basis because the two plants are of identical size, design and scale. The profitability for both companies is averagely the same, although the Rotterdam project handles a bulk of the sales for Diamond Chemical’s European and Middle Eastern market (Bruner, 2001). The upgrade of the Merseyside project will make it more financially viable, although both projects are in strategic locations that allow the company to exploit a larger market segment. The two projects also compare in terms of costs and maintenance where the company currently spends roughly the same in the associating costs for both projects.[Need an essay writing service? Find help here.]
There are a number of problems associated with the use of IRR in analyzing the management and strategic decisions proposed by Morris. First, the IRR may overstate the calculated rate of return, thereby shortening the payback period and resulting in an anticipation of higher amounts of income. Interim cash flows that have been reinvested at a lower rate will result in an overstatement of the rate of return, and this will be a significant problem when making investment decisions. The overstatement will result in overstatement of the forecasts, thus resulting in huge losses when the returns do not materialize.
When IRR and NPV evaluations disagree, then a change to the timing of cash flows will be necessary to correct this problem. The disagreement between the IRR and NPV figures arise when the cash flows for each project have either been rushed or delayed, resulting in different calculations (Hoover & Siegler, 2008). Similarly, when the two figures do not agree, it is also possible to assess the size of each project and ensure its viability to the company’s overall objectives. The size of a project can cause conflicting IRR and NPV figures because the project does not fit into the overall demands set by the investment.
There are a number of risk factors associated with such a project; first, the changes in prices of raw materials, from the petroleum used in transportation to the basic cost of raw materials for producing polypropylene can increase. This would be disastrous because it would render budgets useless as the forecasts will only be showing lower prices than the actual situation on the ground. The risks associated with increases in prices, or generally, inflation, is a serious risk factor that can bring any project to a halt. Considering a progressive price increase for the important commodities required for the project will be necessary to mitigate all the associating risks.
Similarly, there is a risk of rapid changes to technology where the current upgrades will quickly be rendered useless in a short time (Hoover & Siegler, 2008). Technological advancements might result in massive changes to the production of polypropylene within a short time, and this will result in the upgrades on the Merseyside plant as being useless. Considering changes on the engineering front of the project will be very important as it is capable of exposing the company to several damaging risks. The impact of these risks to both projects can be catastrophic because it can easily open the door for other competitors to establish a foothold in the industry and take away Diamond Chemical’s customers permanently.
There are a number of real options available to Diamond Chemicals that they can consider for the long term. First, they should consider outsourcing some of the production operations of the Merseyside plant instead of losing business for the forty-five days that can easily prove to be longer. In an industry with several competitors, the company cannot afford to lose even a single client, and thus it should ensure that its operations are continuous even if it means outsourcing to a competitor (Blaug, 2007). [Click Essay Writer to order your essay]
Another real option available to Diamond Chemicals is to sign an agreement with one of the competitors to transact business on its behalf. This will result in a significant loss of income for the business throughout this forty-five-day period, but it will be better than going out of commission permanently. This will provide an opportunity for the management of the company to analyze the market even further and forecast on the technologies that are likely to be developed in the future. The values of these options are that they will ensure that there is a steady source of income even during the duration of the capital program to provide additional funds to mitigate any risks.
The Merseyside project should be approved because it will increase the capacity of the business as well as its dominance in the market in the future. Businesses should always select the option for upgrading immediately with the current technologies because change has become a single most important determiner in the success of several businesses globally.
Blaug, M. (2007). The Social Sciences: Economics (Methods of inference and Testing theories). The New Encyclopædia Britannica, v. 27, p. 347.
Bruner, R. (2001). “Diamond Chemicals PLC (A): The Merseyside Project” and “Diamond Chemical PLC (B): Merseyside and Rotterdam Projects” In Case Studies in Finance: Managing for Corporate Value Creation, 4th edition. New York: McGraw-Hill.
Grinin, L., Korotayev, A. & Tausch, A. (2016). Economic Cycles, Crises, and the Global Periphery. New York: Springer International Publishing.
Hoover, K. D. & Siegler, M. V. (2008). Sound and Fury: McCloskey and Significance Testing in Economics. Journal of Economic Methodology, 15(1), pp. 1–37.