The vice president of Marketing was less skeptical. He said that with lower costs at Merseyside, Victoria Chemicals might be able to take business from the plants of competitors such as Saône-Poulet or Vaysol. In the current severe recession, competitors would fight hard to keep customers, but sooner or later market would revive, and it would be reasonable to assume that any lost business volumewould return at the time.
Greystock had listened to both the director and the vice president, and chose to reflect no charge for a loss of business at Rotterdam in his preliminary analysis of the Merseyside project. He told Morris:
Cannibalizacion really isn´t a cash flow; there is no check written in this instance. Anyway, if the company starts burdening its cost-reduction projects withfictitious charges like this, we´ll never maintain our cost competitiveness. A cannibalization charge is rubbish!
Concerns of the Assistant Plant Manager
Griffin Tewit, the assistant plan manager and Morris´s direct subordinate, proposed an unusual modification to Greystock´s analysis during a late-afternoon meeting with Greystock and Morris. Over the past few months, Tewitt had been absorbed withthe development of a proposal to modernize a separate and independent part of the Merseyside Works, the production line for ethylene-propylene-copolymer rubber (EPC). This product, a variety of syntetic rubber, had been pioneered by Victoria Chemicals in the early 1960s and was sold in bulk to European tire manufacturers. Despite hopes that this oxidation-resistant rubber would dominate themarket in syntetics, in fact, EPC remained a relatively small product in the European Chemical industry. Victoria, the largest supplier of EPC, produced the entire volume at Merseyside. EPC had been only marginally profitable to Victoria because of the entry by competitors and the development of competing synthetic-rubber compounds over the past five years.
Tewitt had proposed a renovation of theEPC production line at a cost of GBP 1million. The renovation would give Victoria the lowest EPC cost base in the world and would improve cash flows by GBP25,000 ad infinitum. Even so, at current prices and volumes, the net present value (NPV) of this project was (GBP750,000).
Tewitt and the EPC product manager had argued strenuously to the company´s executive committee that the negative NPVignored strategic advantages from the project and increases in volume and prices when the recession ended. Nevertheless, the executive committee had rejected the project, basing its rejection mainly on economic grounds.
In a hushed voice, Tewitt said to Morris and Greystock:
Why don´t you include the EPC project as part of the polypropylene line renovations? The prositive NPV of the polyrenovations can easily sustain the negative NPV of the EPC project. This is an extremely important project to the company, a point that senior management doesn´t seem to get. If we invest now, you can expect that we will have to exit the business altogether in three years. Do you look forward to more layoffs? Do you want to manage a shrinking plant? Recall that our annual bonuses are pegged to the sizeof this operation. Also remember that, in the last 20 years, no one from corporate has monitored renovation projects once the investment decision was made.
Concerns of the Treasury Staff
After a meeting on a different matter, Frank Greystock described his dilemmas to Andrew Gowan, who worked as an analyst on Victoria Chemicals´ Treasury staff. Gowan scanned Greystock´s analysis, and pointed out:Cash flows and discount rate need to be consistend in their assumptions about inflation. The 10% hurdle rate you´re using is a nominal target rate of return. The Treasury staff thinks this impounds a long-term inflation expectation of 3% per year. Thus, Victoria Chemicals´ real (that is, zero inflation) target rate of return is 7%.
The conversation was interrupted before Greystock could...
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