Allchem

ALLCHEM

Introduction

Late in 1989, Peter Green, financial analyst for the Paint Division of Allchem Chemical Company, was reviewing several complex issues relating to possible investment in a new product for the following year, 1990. The product, a specialty coating material, qualified for investment according to company guidelines. However, Mr Black, the Paint Division manager, was fearful that it might be too risky. While regarding the project as an attractive opportunity, Mr Green believed that the only practical way to sell the product in the short run would place it in a weak competitive position over the long run. He was also concerned that the estimates used in the probability analysis were little better than educated guesses.

Company Background

The 11 operating divisions of Allchem were organized into three groups. Most divisions had a number of products centered around one chemical, such as fluoride, sulphur, or petroleum. The Paint Division was an exception. It was the newest and, with sales of R30 million, the smallest division. Its products were specialty industrial products with various chemical bases, such as dyes, adhesives, and finishes, which were sold in relatively small lots to a diversity of industrial customers. No single product had sales over R5 million, and many had sales of only R100 000. There were 150 basic products in the division, each with several minor variations. The Paint Division was one of Allchem's more rapidly growing divisions - 12 percent real growth per year prior to 1990 - with a 18 percent return on total net assets.

Capital Budgeting for new projects

Corporate-wide guidelines were used for analysing new investment opportunities: return criteria were 13 percent for cost-reduction projects, 16 percent for expansion of facilities, and 20 percent for new products or processes. Returns were measured in terms of discounted cash flows after taxes. Mr Green believed that these rates and methods were...