Diamond Chemicals

Team #7:

APEX

Members:
Christina Fisher
Jason Scholl
John Silmon
Josh King
Jeff McGinn
Jeff Mochal

Case introduction
Main Characters:

Lucy Morris: Plant Manager, Merseyside; high achiever; Notre Dame MBA

Frank Greystock: Controller; President, Diamond Chemicals WAG club

Plot Summary:

Major competitor in worldwide chemicals industry & a leading producer of

polypropylene

Morris is recommending a 9 million project;

Renovate and rationalize a production line at Merseyside

To make up for deferred maintenance and increase production efficiency

Several objections to the project have been raised at corporate, and the
initial analysis from Greystock contains errors that need to be fixed

What changes should Lucy Morris ask Frank Greystock to make in his
DCF analysis? What is the justification for each of these changes?
Initial Greystock Analysis
2.0

0.3

3.3

Key Variables
NPV

(1.2)

Assumption
(0.7)

Annual Output (metric tons)

250,000

Output Improvement

7%

Discount Rate

10%

Inflation Rate

0%

GM% Improvement

+100 bps (from 11.5% 12.5%)

Overhead Investment

3.5%/per year

Prelim Engineering Cost

0.5M

Transportation Investment

0.0M

9.0

Greystocks Initial Cash flow &

DCF Analysis Discount Rate
consistency
IRR

12.7

Annual
pretax Impact
Engineering Sunk Transportation Customer
Lost Sales
18.1M Impact
Recommended
charge for
costs
Investment
in Year 2
NPV
overhead

25.9%

Recommended adjustments

Cash flow and discount rate consistency

Annual pretax charge for overhead

Engineering sunk costs

Transportation investment

Lost sales impact

Recommendation #1

Cash flow and discount rate consistency

As Gowen points out cash flows and discount rate need to

be consistent in their assumptions about inflation

10% initial rate proposed by Greystock is a nominal rate real

rate is 7%, Inflation rate is 3%

Two options: Keep the discount rate at 10% and include a 3%

inflation rate in cash flows; OR keep cash flows the same
(with no inflation factor) and change discount rate to 7%

Recommendation: Change discount rate to 7%

Change to NPV

2.0

0.3

3.3
(1.2)

(0.7)

12.7
9.0

Greystocks Initial Cash flow &

DCF Analysis Discount Rate
consistency

Annual pretax Engineering Sunk Transportation Customer Impact

Recommended
charge for
costs
Investment
in Year 2
NPV
overhead

Recommendation #2

Annual pretax charge for overhead

Corporate manual states overhead costs be reflected at 3.5%

rate

This project is expected to reduce overhead costs and should

not be required to charge an annual pretax

Recommendation Remove 3.5% pretax

Change to NPV

2.0

0.3

3.3
(1.2)

(0.7)

12.7
9.0

Greystocks Initial Cash flow &

DCF Analysis Discount Rate
consistency

Annual pretax Engineering Sunk Transportation Customer Impact

Recommended
charge for
costs
Investment
in Year 2
NPV
overhead

Recommendation #3

Engineering sunk costs

0.5M sunk cost for renovation efficiency is included in the

analysis

Sunk costs are retrospective costs that have already been

spent and cannot be recovered, according to the with-without
principle, not relevant to present decisions

Only prospective (or future) costs are relevant to an

investment decision

Recommendation Remove 0.5M sunk cost

Change to NPV

2.0

0.3

3.3
(1.2)

(0.7)

12.7
9.0

Greystocks Initial Cash flow &

DCF Analysis Discount Rate
consistency

Annual pretax Engineering Sunk Transportation Customer Impact

Recommended
charge for
costs
Investment
in Year 2
NPV
overhead

10

Recommendation #4

Transportation investment

2M cost for purchasing new rolling stock to support

anticipated future growth was not included in the DCF analysis

Cost should be considered a cash outflow and expense

The tanker cars are necessary to accommodate the increased

throughput that is associated with this project

Transport Division and Merseyside *One Company*

Recommendation Include 2M transportation investment

and the 10 year depreciation

11

Change to NPV

2.0

0.3

3.3
(1.2)

(0.7)

12.7
9.0

Greystocks Initial Cash flow &

DCF Analysis Discount Rate
consistency

Annual pretax Engineering Sunk Transportation Customer Impact

Recommended
charge for
costs
Investment
in Year 2
NPV
overhead

12

Recommendation #5

Lost sales impact

Greystocks DCF Analysis concludes that all customers will

return within one year

Conservative approach concludes not all customers will return

so quickly and this will impact sales and should be included in
the analysis

Potential factors include the overall state of the economy

and improving competitor efficiencies

Reduces both the NPV and IRR but the project remains
attractive

Recommendation Include customer losses

13

Change to NPV

2.0

0.3

3.3
(1.2)

(0.7)

12.7
9.0

Greystocks Initial Cash flow &

DCF Analysis Discount Rate
consistency

Annual pretax Engineering Sunk Transportation Customer Impact Recommended

charge for
costs
Investment
in Year 2
NPV
overhead

14

Summary of adjustments to NPV

2.0

0.3

3.3
(1.2)

(0.7)

12.7
9.0

Greystocks Initial Cash flow &

DCF Analysis Discount Rate
consistency

Annual pretax Engineering Sunk Transportation Customer Impact Recommended

charge for
costs
Investment
in Year 2
NPV
overhead

15

Conclusion
Recommended Changes
2.0

0.3

3.3
(1.2)

Key Variables

Initial Assumption

Annual Output (metric tons)

250,000

250,000

Output Improvement

7%

7%

Discount Rate

10%

7%

Inflation Rate

0%

0%

GM% Improvement

8.7%

8.7%

Overhead Investment

3.5%/per year

0%

Prelim Engineering Cost

0.5M

0.0M

Transportation Investment

0.0M

2.0M

9.0

Greystock's Initial
Cash flow
&
Lost Sales
Impact
DCF Analysis Discount Rate
consistency

Changes

(0.7)

12.7

Customer Impact Recommended

Annual pretax 18.1M
Engineering Sunk Transportation
(27.1M)
charge for
costs
Investment
in Year 2
NPV
overhead

IRR
25.3%

16