This memorandum will discuss the economical feasibility of Nucor adopting SMS’s CSP process. It will also provide recommendations on whether to accept or reject this potential investment. These recommendations will be determined based on the examination of a series of cash flow, scenario, and strategic analyses.
Internal Investment Criterion Top management at Nucor Corporation has determined its own internal investment criterion in determining whether to accept or reject a new investment project. Currently, the company judges the potential success of a project by its ability to achieve a 25 percent return on assets after 5 years. This ratio measures how efficiently Nucor’s assets are able to generate revenue.
Based off current market growth rate predictions, an investment in the CSP process will result in a return on assets of 29.33 percent. (Exhibit 1) This number exceeds the initial investment qualification by a promising margin of about 4 percent. Therefore, based on the internal criterion, this CSP process is a relatively safe and profitable investment. Traditional Investment Criteria
Investing in the CSP process meets the current internal investment criterion, however, there are other, more traditional investment criteria that can be analyzed. Net present value of the discounted future cash flows and the internal rate of return are both important attributes that can measure the future success of a project. If Nucor were to invest in this new project, the net present value would be negative 34.02 million dollars. (Exhibit 1)
This suggests that the investment should not be undertaken and would result in negative future economic value for the company. Conversely, the internal rate of return associated with the adoption of the CSP process is a positive 13.07 percent. This number is less than the stated discount rate of 15 percent, which is directly reflected in the negative net present value result. Based on these two traditional measures, the CSP process is not an economically feasible investment for Nucor and should not be undertaken.
Decreased Annual Growth Rate The current predicted future growth in steel price is considerably smaller than the historical value. This drop in price reflects problems faced industry wide by all steel producers. Threats to the industry include the uncertain future adoption of new steel making technology as well as increased global imports of the resource. Thus, it is important to analyze the effect of a decrease in the annual growth rate of the price of steel on Nucor’s potential investment in the CSP process.
Nucor Corporation can handle a price decrease of no more than one percent before it is unable to reach its target of a 25 percent return on assets in five years. At an annual growth rate of 3.37 percent, the company can expect to realize a return on assets of 25.04 percent. (Exhibit 2) If the steel industry were to experience further price decreases, Nucor has some room financially to absorb the effects of the price change and continue to be successful. However, it is important to note that the project would still result in a negative net present value and an internal rate of return less than the discount rate. This further illustrates the discontinuity between internal criterion and traditional criteria for the future success of a project.
Future of Integrated Steelmakers As new technology becomes available to steelmakers, the call to modernize becomes increasingly strong. Large integrated steelmakers must make the choice whether to modernize mills that are currently unmodernized or continue with their current strategy. If the mills are modernized the integrated steelmakers will have a net present value of 39.80 million dollars and an internal rate of return of 15.28 percent. (Exhibit 3) These numbers indicate that modernization would be feasible and beneficial economically.
However, if the mills remain as they are, the integrated steelmakers can expect a net present value of 675.22 million dollars. (Exhibit 4) This number is significantly larger than the value gained from modernizing the mills. Thus, although modernization would be profitable, it would be more economically beneficial for the integrated steelmakers to continue with their current operating strategy. In the near future, Nucor can expect little competition from the large steelmaker corporations, as the costs associated with adoption of the new technology do not produce sufficient gains. However, if the price of adoption were to decrease, the integrated steelmakers could be incentivized to modernize and compete directly with Nucor and other minimills.
After examination of three key analyses on the potential success of adopting the CSP process, it is recommended that Nucor does not invest in the project at this time. There are notable disparities between the company’s internal measures of success and those used traditionally. These differences can be dangerous and lead to acceptance of more risky and potentially harmful projects. Top executives at Nucor should reevaluate their internal standards for determining a successful investment to avoid any future financial distress. If the company takes this time to develop its internal operations strategy, SMS could further improve its CSP process and make it less costly. For the time being, Nucor is relatively safe from competition from the larger integrated steelmakers and would benefit from waiting to invest in this new technology.
This memorandum addressed the economic feasibility of Nucor adopting SMS’s new thin slab technology. Results of cash flow, scenario, and strategic analyses were used to recommend the most economically beneficial strategy. At this time it would be in Nucor’s best interest to delay adoption of the CSP process.