Diamond Chemicals
Content
BS1707 Corporate Finance
Diamond Chemicals – Questions
Question 1
Why does Greystock include the engineering costs of £500,000 in his
analysis?
Because it’s a cash expense which related to the project. This expense
had been spent over the preceding nine months on efficiency and
design studies for the renovation, so it is recorded in the first year in
the free cash flow analysis in the exhibit 2.
Question 2
Is Greystock right in not including a charge for the increased use of
rolling stock in his analysis? Why?
When the analysis is conducted from the Merseyside Plant perspective,
he is right. As he said, the transport division is an independent
department from Merseyside Project, and the transport division don’t
pay cash for what they are doing at Merseyside. However, if we analyse
it from the whole company’s perspective, the overall impact should be
considered. If the throughput of the Merseyside Plant exceeds the
capacity of the transport division and the transport division need to buy
rolling stock by cash because of that, we need to take it into the
consideration for the whole company.
When the analysis is conducted from the Merseyside Plant perspective,
he is right. However, we need to analyse it from the whole company’s
perspective, so the overall impact should be considered. If the
throughput of the Merseyside Plant exceeds the capacity of the
transport division and the transport division need to buy rolling stock
by cash because of that, we need to take it into the consideration for
the whole company.
Question 3
Is Greystock right in stating that “a cannibalization charge is rubbish”?
Why?
In corporate finance, we care more about cash, because cash is king.
As cannibalization charge is not a cash flow, we should not take that
into consideration. Besides, as the marketing department leader said,
the market will recover.
Greystock is wrong because we need to take the incremental effect of
the project for the whole company, so we need to subtract the
cannibalization effect. For this project, it will bring positive effect to
Merseyside Plant and Negative effect to Rotterdam Plant if there is
cannibalization. So we need to consider if the overall effect is positive.
Question 4
One of the ‘performance hurdles’ employed by Diamond Chemicals to
assess a potential project is its impact on EPS (earnings per share)
growth. Is this a smart hurdle to use? Why?
The EPS is a smart hurdle, but it’s not as smart as NPV and IRR,
because it considered the project’s impact to net income, not the
impact to cash, but in corporate finance, we care more about cash as
cash is king. So in my opinion, EPS can be used as a complementary
hurdle to NPV and IRR, but it should not be one of the major hurdle we
use.
Diamond Chemicals – Questions
Question 1
Why does Greystock include the engineering costs of £500,000 in his
analysis?
Because it’s a cash expense which related to the project. This expense
had been spent over the preceding nine months on efficiency and
design studies for the renovation, so it is recorded in the first year in
the free cash flow analysis in the exhibit 2.
Question 2
Is Greystock right in not including a charge for the increased use of
rolling stock in his analysis? Why?
When the analysis is conducted from the Merseyside Plant perspective,
he is right. As he said, the transport division is an independent
department from Merseyside Project, and the transport division don’t
pay cash for what they are doing at Merseyside. However, if we analyse
it from the whole company’s perspective, the overall impact should be
considered. If the throughput of the Merseyside Plant exceeds the
capacity of the transport division and the transport division need to buy
rolling stock by cash because of that, we need to take it into the
consideration for the whole company.
When the analysis is conducted from the Merseyside Plant perspective,
he is right. However, we need to analyse it from the whole company’s
perspective, so the overall impact should be considered. If the
throughput of the Merseyside Plant exceeds the capacity of the
transport division and the transport division need to buy rolling stock
by cash because of that, we need to take it into the consideration for
the whole company.
Question 3
Is Greystock right in stating that “a cannibalization charge is rubbish”?
Why?
In corporate finance, we care more about cash, because cash is king.
As cannibalization charge is not a cash flow, we should not take that
into consideration. Besides, as the marketing department leader said,
the market will recover.
Greystock is wrong because we need to take the incremental effect of
the project for the whole company, so we need to subtract the
cannibalization effect. For this project, it will bring positive effect to
Merseyside Plant and Negative effect to Rotterdam Plant if there is
cannibalization. So we need to consider if the overall effect is positive.
Question 4
One of the ‘performance hurdles’ employed by Diamond Chemicals to
assess a potential project is its impact on EPS (earnings per share)
growth. Is this a smart hurdle to use? Why?
The EPS is a smart hurdle, but it’s not as smart as NPV and IRR,
because it considered the project’s impact to net income, not the
impact to cash, but in corporate finance, we care more about cash as
cash is king. So in my opinion, EPS can be used as a complementary
hurdle to NPV and IRR, but it should not be one of the major hurdle we
use.
