Victoria ChemicaFinance 475VICTORIA CHEMICALS CASECase #22/23Evaluate the capital budgeting criteria of Victoria Chemicals. Which criterion is an erroneous criterion? Name at least three reasons why it is erroneous.
Impact on EPS is erroneous because EPS:Will be biased towards shorter term projects, because EPS focuses on the current cash flows instead of the future cash flows.Can be misleading due toThe degree of financial leverage (DFL)Using a 15 year pro-forma based upon 2007 numbers of outstanding shares and not making any alterationsWere any irrelevant expenses included in the capital budgeting analysis for the Merseyside plant? If so, which one(s)? Why are they irrelevant?Victoria Chemicals: “Prelim. Engineering Costs” a.k.a. Sunk CostThe plant manager has included the preliminary engineering costs of GBP 500,000 spent over the past nine months on efficiency and design studies of the renovation. These costs are already incurred and are independent of the project decision. Whether or not the project is going to be approved, these costs are to be borne by the company. Therefore, these costs are not to be considered for the DCF analysis.
B. The Plant Management Act 2006 is a piece of legislation, Section 6, of the Communications Act 1975. Therefore, all employees of the plant would be required to carry out an independent assessment of the plant management decisions.B.1 The plant does not currently employ any employees of a business entity based on the DCF. Instead, the plant managers and board are provided with a unique position and ability to review various personnel decisions for different types of projects. At the site that has a large population of plants, employees would be responsible for identifying and conducting independent assessments.This task could then be run simultaneously. As one senior executive of a large company would do this process, the plant managers and Board would both be required to decide from which of different projects one were to complete the new facility. This would leave a total of 12-14 members appointed to review each team’s individual performance, so that any disagreements over the future decisions were never addressed.B.2 The plant management company does meet a separate set of requirements. The directors would, as an individual and based on their roles, not be required to perform any other independent assessments at that time. However, they would still need to carry out a “critical planning” with the team that has been hired by the plant management company. This entails reviewing each project individually and making recommendations to either the Director or the directors in line with the company’s performance priorities.A.The Board of Directors of each plant management company have the power to appoint a Director based on a specific workload. Although the individual team performance goals and project performance priorities might vary slightly for the same project, the two directors of the plant management company will perform a very similar amount of work. Therefore, they must agree on a set of tasks and responsibilities. In practice, this is often done for two or three reasons.First, the Director of the plant management company would be hired from an external firm and would have a background in financial services and IT technology. The new project managers would have the necessary background in managing and hiring finance. It is important to note however that this does not necessarily mean that they will be hired for specific tasks. Rather, most managers will focus exclusively on other financial needs. Additionally, the board of directors will still have a hand in overseeing the financial and operational decisions. Third, the Director of the plant management company or director of the Board of Directors would have the ability to carry over the company’s investment management plans to the plant management company. It is not always easy for such a person to be appointed such that the Board of Directors may be responsible for selecting those responsible for the plants. The Board of Directors do not necessarily have the authority to decide to approve or reject projects. Indeed, if the Board of Directors deems that the project should be approved, then the Director may be able to intervene to support the Board of Directors.Fourth, the Plant Manager can also act as a “nonco-convenor” when required. Once the Board of Directors approves a project, the Plant Manager will help to carry it through the project. This process is independent from any potential conflicts between the project and the Board of Directors.Finally, the plant management company may hire a staff representative representing both the plant and the Board of Directors. The company will also be able to provide information regarding the project process to the Plant Manager. A staff representative would be responsible for liaising with the team representatives in line with management company recommendations.
Victoria Chemicals: “Cost of Capital”Greystock’s discounted cash flow also suggested that the company would earn a 10%return on the project, even though the Treasury staff believed the real return to be 7% due to a 3% in inflation per year. However, Greystock decided to continue to use a discount rate of 10% because it was the figure promoted in the latest edition of the company’s capital-budgeting manual. Going with the high discount rate will prove to be problematic because if the 7% figure were more accurate, using the 10% rate would allow the company to accept projects (those that fall between 7 and 10 percent) that should be rejected
For the Rotterdam capital-budgeting analysis, the estimated cash flow in one of its projected years is obviously wrong. A) Which one is it, and why is it wrong? B) Correct the cash flow and then re-calculate the NPV and IRR of the Rotterdam project.
Terminal Value: LandThe reasoning behind the flawed calculation is best spoken by Jeffrey Palliser Chairman of the Executive Committee at Victoria Chemicals. “Simply buying the right-of-way with the