This week we will be doing a Capital Budgeting case. We will combine Case 24 and 25 into one long case where Victoria Chemicals will be dealing with a Mutually Exclusive Capital Budgeting decision.
You should reread the Principles of Finance textbook chapters (and your notes) dealing with the topic of Capital Budgeting and the decision rules used by companies to determine which projects are acceptable (and profitable).
The PPT files for the relevant chapters have been uploaded to Canvas.
Victoria Chemicals is considering upgrading its ageing plants in Merseyside and Rotterdam. Assume that they can do only one right now. You have to analyze all the given information for both plants and recommend one for updating.
The uploaded spreadsheet will help you with the quantitative analysis. Before you do that, there are some issues you have to deal with (qualitatively) in your case report.
In Case 24, there are sections titled Concerns of the Transport Division, Sales and Marketing Dept., Assistant Plant Manager, and Treasury Staff. Without doing any calculations, you have to discuss how the company should deal with each of these issues. You need to determine what is relevant (and what is not) in Capital Budgeting. Remember that to make the decision, you will be calculating NPV for each project using the given spreadsheet.
On page 354 in Case 24, they list four decision rules used by the company. Two of them are incorrect and should never be used in Capital Budgeting. Identify them, and explain why they should not be used.
In Exhibit 1 on page 355, they give you some data about the competing plants in this industry. What do the numbers tell us?
Exhibit 2 on page 356 should be used for the NPV calculations. For simplicity, you can focus only on the NPV numbers, although IRR is calculated at the same time. Some of the assumptions (and numbers) need to be corrected before you get the right NPV. Remember that NPV should be calculated only with the relevant incremental (or marginal) after-tax cash flows. If the cash flow is not relevant or marginal, it should not be used. Also, only real cash flows should be used, and not accounting numbers.
In Case 25, the only â€˜issueâ€™ you have to deal with is the option on the right-of-way. Think very carefully about this land purchase decision. What should the company do? Make the appropriate adjustments in the NPV calculations.
Exhibit 1 on pages 362-363 should be used for the NPV calculations. The same rules used in Case 24 apply here. Whatever assumptions you make should be used consistently for both cases.
The â€˜Erosionâ€™ numbers given here apply to the Sales Cannibalization effect mentioned in Case 24. If you think it is plausible and relevant, use the same number in both cases to reduce the NPV. Or donâ€™t. You can always have alternate scenarios when calculating NPV for Capital Budgeting Projects.
Make a recommendation after you have done all the analysis. What do you recommend the company should do in the long run? Justify your answer with appropriate arguments and data. Are there any additional factors/issues that you think should be considered in the decision making process?
Upload the spreadsheet as a separate document along with your written case report.