Details of McCormick Details of McCormick Plant Proposal McCormick & Company is

Question

Details of McCormick Details of McCormick Plant Proposal McCormick & Company is considering a project that requires an initial investment of $24 million to build a new plant and purchase equipment. The investment will be depreciated as a modified accelerated cost recovery system (MACRS) seven-year class asset. The new plant will be built on some of the company's land, which has a current, after-tax market value of $4.3 million. The company will produce bulk units at a cost of $130 each and will sell them for $420 each. There are annual fixed costs of $500 thousand. Unit sales are expected to be 150,000 each year for the next six years, at which time the project will be abandoned. At that time, the plant and equipment is expected to be worth $8 million (before tax) and the land is expected to be worth $5.4 million (after tax). To supplement the production process, the company will need to purchase $1 million worth of inventory. That inventory will be depleted during the final year of the project. The company has $100 million of debt outstanding with a yield to maturity of 8 percent, and has $150 million of equity outstanding with a beta of 0.9. The expected market return is 13 percent, and the risk-free rate is 5 percent. The company's marginal tax rate is 40 percent. Should the project be accepted?

5. What is the total operating cash flows, given the following operating cash flows: Sales = 150,000 x $420 = $63,000,000 Costs = 150,000 x $130 + $500,000 = $20,000,000

6. Create an after-tax cash flow timeline.

7. What is the total expected cash flows at the end of year six? The $4.3 million is an opportunity cost and must be included at date 0 as a cash outflow. If the project is accepted, however, the land can be sold in six years for $5.4 million.

8. Find the NPV using the after-tax WACC as the discount rate. 9. Find the IRR. 10. Should the project be accepted? Discuss whether NPV or IRR creates the best decision rule.

Could you show the numbers being calculated so I can know how to do it?

Explanation / Answer

First of all let us find WACC

Cost of debt = YTM(1-Tax rate)

=8%(1-0.4)

=8%(0.6)

=4.8%

Cost of equity = Risk free rate of return+Beta(Market Return Rate less Risk free rate of return)

=5%+0.9(13%-5%)

=5%+0.9(8%)

=5%+7.2%

=12.2%

Statement Showing WACC

Statement showing Depreciation

Statement Showing NPV

Terminal Cash flow

Source of Capital Amount Weight K WACC= Weight*K Equity 150 0.6 12.20% 7.32% Debt 100 0.4 4.80% 1.92% 250 9.24%

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