I would choose Merseyside project rather than Rotterdam’s not only for its superior prospect based on the quantitative criteria, but also for a more rational strategy consideration. For the four investment criteria, here’s the elaboration.
NPV. Since the two plants are of identical scale, age, design and similar project size, it makes sense to use NPV to compare the two projects. Not taken into account the erosion at Merseyside, the projected NPV of Rotterdam project is GBP4.49 million (GBP15.06 million- GBP10.57 million) higher than that of Merseyside project. IRR. The IRR of the Merseyside project (24.3%) is 5 percentage points higher than that of Rotterdam project (17.3%). Payback. Based on the cumulative free cash flow calculated, the payback period of Merseyside (3.8 years) is four years less than that of the Rotterdam projects (7.9 years), which is a big difference for a 15-year project. Growth in EPS. Calculated as the average annual EPS contribution of the project over its entire economic life (15 years), the average annual addition to EPS of Merseyside and Rotterdam projects are GBP0.022 and GBP0.030 respectively, with a difference of GBP0.008.
A quick look at the four quantitative criteria might suggest that the two projects are of similar value to Victoria Chemicals; NPV and Growth in EPS are in favor of Rotterdam while IRR and Payback are in favor of Merseyside. However, taken into consideration the current status of the industry, the four criteria should not be of the same weight. As suggested by the director of sales, the industry is in a downturn with a possible oversupply issue around the corner. A price competition can be foreseen among the top suppliers of polypropylene in Europe, which would require a more liquid financial status of the company. A 7.9-year payback suggested by Rotterdam project might put the company into a dangerous financial situation among fierce competition and the company might even have no chance to enjoy the proposed benefits (higher NPV and Growth in EPS). With this being said, the Merseyside project is a better choice based on the quantitative analyses.
From the strategy point of view, Merseyside project is still the project that is easier to receive a green light from the senior management of the company for the following reasons. 1) The new Japanese process-control technology is still too young to ensure the stable efficiency gains across each of the production facilities. Even time will help reduce the variability of the efficiency gains generated by the system itself, none of the machinery at Victoria Chemicals’ two plants has been tested for the compatibility for this Japanese technology. Admittedly, the potential success of the Rotterdam project will benefit the company significantly in terms of both market position and financial status, it was based on too many assumptions and thus less persuasive. 2) Although the Rotterdam project is a phased program, it is irreversible due to the complexity of the technology and the extent to which it would permeate the plant. That is to say, once the senior management choose the Rotterdam project and the new technology turns out to be less than satisfactory, all the investments are wasted. Moreover, it would be hard to sell the purchase option of a pipeline and its right-of-way if the plan didn’t work out due to the strong objection from some senior executives.
3) It would be harder for Victoria Chemicals to justify to investors its investment in Rotterdam project than in Merseyside project. Rotterdam project is dependent on a technology with unforeseeable future and propylene supply that are subject to vary over time. These factors are difficult to quantify and for investors, who have already cast doubt on the company’s financial performance due to the corporate raider Sir David Benjamin, these can exacerbate their unsecure feeling towards the company and thus worsen the projected EPS. 4) Assume the Rotterdam project can achieve all the predicted financial goals and benefit both plants, there’s no reason that the new control technology has to be installed now. O the contrary, Merseyside project is comparatively simpler for execution and the effects of it can be seen sooner (only a 1.5 months downtime for construction is needed versus 12 months downtime required by Rotterdam project).
Given the facts mentioned, why not choose Merseyside project now and wait for two years to see how the market develops and decide whether to install the new control technology that might be more mature and stable at that time? Some may argue that the Merseyside project is too conservative and might jeopardize Victoria Chemicals’ chance to become the pioneer in using advanced process control technology, however, based on aforementioned analysis, I believe the Merseyside project will be the right choice at this timing but the flexibility of adding the technology in the future should be retained.