Empirical Chemical

SUBJECT: Empirical Chemical Case

BACKGROUND: In the winter of 1992 Empirical Chemicals was debating whether or not to move forward with a capital project with an initial outlay of 7 million to renovate the plant in Merseyside which had been operating with outdated processes and the plant manager wished to modernize the facility. The other plant utilized by Empirical is in Rotterdam and is identical to Merseyside. In order to complete the project Empirical must close down the Merseyside plant for 60 days. While the plant manager is very optimistic about the project, several concerns had been raised by other departments within the company.

KEY ISSUES: We have identified four key issues within the proposal that need to be addressed.

• Preliminary Engineering Cost: The Preliminary costs of 500,000 are irrelevant because they would have been made regardless of whether or not the project moves forward or not; they are a sunk cost.

• Transport Division Rolling Stock: An outlay of 2 million needed to fund the additional tank cars needed for the increased through put and to be able to handle the rolling stock. We reflected this through an increase in the initial investment, bringing it to 9 million. We don’t agree with the idea that the transportation department should put the cost on their books because they’re directly influenced by the project. They are also essential in the plants day to day operations.

• Cannibalization: We believe that the company is being overly optimistic with their belief that they will recover 100% of their customers from the plant downtime and that they will not eat away at Rotterdam’s sales. We used more conservative figures for the gross margin to reflect the possible loss of customers and cannibalization of sales. A reduction of just .11% from the projected increase in margins (12.9% as suggested by the company) makes the NPV of the project negative and also barely achieves the hurdle rate.

• Possible Addition of EPC...