Victoria Chemicals Plc. - the Good, the Bad, and the Merseyside

The Good, The Bad, and The Merseyside

The future of Victoria Chemicals will be influenced by the viability of The Merseyside Project and after extensive evaluation we have concluded that the project should be funded for several reasons. First, and most importantly, the Merseyside project clears the hurdle return rate of 10% required by the company, as reflected in the updated attached valuation model.  The model has been adjusted to remove sunk costs and reflect the real discount rate of 7%, net of the impact of inflation, to more accurately represent the value of the project. The attached what-if analyses highlight that the positive returns required of capital investments will be satisfied. Furthermore, the Merseyside project provides an IRR of 24.9% to the company and the project carries a positive NPV of $15.06 million on the $12 million required investment. After careful consideration of the concerns that have been raised by different parts of the organization, we recommend proceeding with the project as it represents an appropriate use of capital for Victoria Chemicals.

With regards to the valuation of the project, several discrete items will be addressed in this memo. Sunk costs have been removed from the model, as previously mentioned, because they are not recoverable regardless of the status of the Merseyside project and will have to be recognized as an expense whether or not the project proceeds. Cannibalization of volume from existing activities at the firm was not specifically addressed in the valuation model because one of the assumptions of our recommendation is that the market can absorb the excess output without impact on pricing and competition. Additionally, the project will utilize pre-existing excess transportation capacity which is not explicitly reflected in the valuation model. The capacity will continue to sit idle if not used in conjunction with the Merseyside project. The standard corporate overhead allocation of 3.5% was applied to the valuation of the project in accordance with the corporate manual. Cash flows of unrelated projects have not been contemplated as part of the decision making process for the Merseyside project.