Case

Concerns of the Treasury Staff

The 10% discount rate used by Greystock for his DCF analysis is a nominal figure. According to the Treasury staff, the long-term expected inflation rate per year is 3%, making the real target rate of return as 7%.

Revised DCF analysis

As pointed out by the Treasury staff, the cash flows and the discount rate have to be consistent. The group has two options. It can keep the 10% and turn the cash flow into nominal values, or it can change the discount rate to 7% and keep the cash flow as it is. The group has decided to go with the second option to make the computations simpler.

Concerns of the Assistant Plant Manager

Griffin Tewitt, the assistant plant manager, wanted Greystock to include in the analysis his proposal to modernize the production line for ethylene-propylene-copolymer (EPC) rubber. Previously, this proposal was rejected due to its negative net present value (NPV) and low profit margins. Griffin pointed out that the positive NPV of Greystock’s project could easily sustain the negative NPV of the EPC project.

Revised DCF analysis

The group has decided not to include the EPC project into the revised DCF analysis. The negative NPV of this project would hold the company back from maximizing its returns. Also, it is uncertain whether EPC would remain competitive in the market, since it is mentioned that there is a development of competing synthetic-rubber compounds which could act as substitutes for this product.