Instructions To Complete This Workbook Answer

Instructionsinstructionsto Complete This Workbook Answer The Questi

Instructions instruction to complete this workbook, answer the questions on each worksheet in the space provided. Financing and Investing Questions 1. McCormick & Company is considering purchasing a new factory in Largo, Maryland. The purchase price of the factory is $4,000,000. McCormick & Company believes they can produce a net cash inflow of $780,000 a year for 10 years. If the discount rate is 14%, should McCormick & Company purchase the factory at the $4,000,000 asking price? 2. If McCormick & Company decides to purchase the new factory in Largo, they need to consider relevant after-tax cash flow. McCormick & Company estimated their potential first-year sales revenue at $780,000, expenses at $225,000, and depreciation expense at $150,000. McCormick's marginal tax rate is 40 percent (21 percent federal and 19 percent state combined). What is first-year relative cash flow? 3. The estimated relevant annual expected cash flows (C1) associated with the purchase of the new factory in Largo are as follows: Year C1 PV(C1) 1 ? ? 2 $291,000 $202,083 3 $191,000 $110,532 4 $306,000 $147,569 5 $424,000 $170,396 In year 3, the estimated relevant annual expected cash flows represent funds used to pay operating expenses for subsequent years. All estimated relevant annual expected cash flows include a risk premium of 13 percent, which has already been applied to the cash flows above. Solve for cash flow for Year 1 based on your answer in Question 2. Then, solve for present value (PV) for Year 1. What is the total of present value for all five years? Should the factory be purchased? Why or why not? 4. McCormick & Company is also considering introducing two new product lines to be made at the new factory (if it is purchased). As a new member of MCS's finance team, you are asked to determine whether McCormick & Company should invest in the two product line expansions. Project A has lower future cash flows than Project B, but because Project A is more closely related to McCormick's existing product line, the company feels it is less risky than Project B. You’ve done some more analysis and have formulated the following future profits for each project (with the first cash flow occurring one year from now). Each project is expected to have a life of 5 years. Year 1 Year 2 Year 3 Year 4 Year 5 Project A $5M $10M $10M $15M $15M Project B $5M $10M $15M $20M $20M You also believe that each project will require about $40 million in upfront investment. Finally, based on the different risk assumptions, you believe that Project A should use a discount rate of 7 percent, while Project B will have a discount rate of 20 percent. Which project or projects should the company undertake? Answer Questions 1 to 4 here. Show your calculations. Valuation of Performance Show your answers below: Questions 1. McCormick & Company is considering buying a new factory in Largo, Maryland. The company is considering issuing additional common stock to finance the purchase of the factory. McCormick & Company stock has recently paid a dividend payment of $0.52 per share. Dividends are expected to grow 8.5% per year for the next five years. The required return on the stock is 12 percent. Determine the intrinsic value of the stock, also known as today's stock price. 2. The current price of an American call option with exercise price $80, written on McCormick & Company stock is $41.40. The current price of one McCormick & Company stock is $123.13. If you were to sell the stock, how much money would you expect to make? 3. McCormick & Company is considering establishing new products in a new factory in Largo, Maryland. The project is expected to last for 8 years. To determine the right financing option, you need to determine the appropriate discount based on the weighted average cost of capital. The cost of equity is estimated using the capital asset pricing model. Cash flows are assumed to be steady, the nominal risk-free rate for the short-term US government treasury bills is 1.5%, the 10-year government bonds rate is 2.5% and inflation rate is 2.54%. What is the real risk free rate? Then, assume a beta of 1.2 and a market return of 5%. What is the cost of equity? 4. McCormick & Company is considering purchasing a new factory in Largo, Maryland. After you and your team have conducted an analysis of alternative investments and cost of capital, McCormick has decided that a risk premium of 13 percent is appropriate for the investment into a new factory. Adding the risk premium to the current risk-free rate of 7 percent, what is the minimum acceptable rate of return? Answer Questions 1 to 4 here. Show your calculations. Annuities Answer Questions 1 and 2 here. Show your calculations. Questions 1. Liz has retiring from the U S Postal Service and will turn 70 next year. After 39 years of service, her monthly pension is $7,500. She does not qualify for Social Security. Liz has accumulated $700,000 in her thrift savings plan. The government requires that she convert it to an annuity or move it to a IRA. All of the money is pretax and tax can be avoided if it is moved to the IRA. The annuity will be calculated based on her life expectancy of 17.5 years after age 70. The current US Treasury Long term bond rate is 3.0%. How much will she get as an annuity monthly payment? Should Liz take the annuity or move the money to the IRA.? 2. Kathy plans to move to Maryland and take a job at McCormick as the Assistant Director of HR. She and her husband Stan plan to buy a house in Garrison, MD and their budget is $500,000. They have $100,000 for the down payment and McCormick will pay for closing costs. They are considering either a 30 year mortgage at 4.5% annual rate or a 15 year mortgage at 4%. Calculate the monthly payment for each. Property taxes and insurance will add $1,000 per month to which ever mortgage they choose. What should Kathy and Stan do?

Paper For Above instruction

The decision to purchase a new factory involves comprehensive financial analysis, incorporating net cash flows, present value calculations, and risk assessments to determine if the investment is justified. This analysis ensures that McCormick & Company invests in projects that maximize shareholder value and align with its strategic goals. This paper discusses the financial considerations of the factory purchase, including cash flow evaluation, project risk, potential returns, and strategic expansion through new product lines, culminating with a valuation of stock and investment options for the company’s leadership.

Financial Evaluation of the Factory Investment

McCormick & Company’s consideration to acquire a factory in Largo, Maryland, exemplifies standard capital budgeting decisions. The central question concerns whether the present value of expected cash inflows exceeds the purchase price of $4,000,000, discounted at the appropriate rate. The annual net cash inflow of $780,000 for ten years needs to be discounted at 14%, aligning with their cost of capital. Using the formula for net present value (NPV), the present value (PV) of an annuity can be calculated to evaluate potential profitability.

The formula for the present value of an annuity is PV = C * [(1 - (1 + r)^-n) / r], where C is the annual cash flow, r is the discount rate, and n is the number of years. Plugging in the values:

PV = 780,000 [(1 - (1 + 0.14)^-10) / 0.14] ≈ 780,000 5.747 ≈ $4,477,260.

Since the PV exceeds the purchase price of $4 million, the project appears financially justifiable from a net present value perspective, indicating a good investment if other qualitative factors align.

Assessment of First-year Cash Flows and Tax Implications

To determine the first-year relative cash flow, McCormick & Company’s estimated revenues, expenses, and depreciation must be considered, alongside their tax effects. The gross profit is revenue minus expenses: $780,000 - $225,000 = $555,000. Subtracting depreciation of $150,000 yields taxable income of $405,000.

Tax at 40% on $405,000 results in tax payments of $162,000, leaving net income of $243,000. Adding back depreciation (which is a non-cash expense) of $150,000 gives the first-year cash flow:

Cash flow = Net income + Depreciation = $243,000 + $150,000 = $393,000.

Cash Flows and Present Value Calculations for the Project

Applying the adjusted year-one cash flow to the valuation, and considering the PVs for subsequent years, enables a comprehensive analysis. The total PV across all five years sums to approximately $732,163, which is below the cumulative cash flows considering the risk premium adjustments. The sum of PVs for all five years adds a robust perspective on the project’s potential profitability.

Given the calculations, if the initial investment cost of $4 million exceeds the sum of the discounted cash flows, the project may not meet the investment criteria, suggesting the factory should not be purchased solely based on financial returns. However, strategic factors and qualitative benefits also inform this decision.

Investment in New Product Lines and Risk Analysis

The decision to expand into new product lines involves analyzing the projected profits over five years, investment costs, and discount rates reflecting the risk. Project A, with lower projected cash flows but closer relation to existing operations, is less risky with a 7% discount rate, while Project B, with higher cash flows but greater risk, uses a 20% rate.

Calculating net present values (NPVs) for each project involves discounting each year's profit using their respective rates and deducting the upfront investment. For Project A:

NPV_A = (5M/1.07 + 10M/1.07^2 + 10M/1.07^3 + 15M/1.07^4 + 15M/1.07^5) - 40M ≈ $20.9 million - $40 million ≈ -$19.1 million.

For Project B:

NPV_B = (5M/1.20 + 10M/1.20^2 + 15M/1.20^3 + 20M/1.20^4 + 20M/1.20^5) - 40M ≈ $8.4 million - $40 million ≈ -$31.6 million.

Neither project exhibits a positive NPV under these assumptions, indicating reconsideration or reassessment of the projects’ viability.

Stock Valuation and Investment Analysis

Using the dividend discount model (DDM) to ascertain the stock’s intrinsic value involves projecting dividends and discounting them at the required rate of return. The dividend next year is $0.52 * (1 + 0.085) ≈ $0.5642. The intrinsic value V is calculated as V = D1 / (r - g):

V = 0.5642 / (0.12 - 0.085) = 0.5642 / 0.035 ≈ $16.12 per share.

This suggests that the stock's fair value is significantly higher than its current market price, indicating potential undervaluation.

Options and Market Positions

The potential profit from selling the stock at $123.13, with an option priced at $41.40, is calculable by subtracting the current stock price:

Profit = $123.13 - $41.40 ≈ $81.73 per share.

This highlights the potential profitability of the stock and strategy involving call options.

Cost of Equity and Weighted Average Cost of Capital

The real risk-free rate is derived by adjusting the nominal risk-free rate (1.5%) for inflation:

Real risk-free rate = (1 + nominal rate) / (1 + inflation) - 1 ≈ (1 + 0.015) / (1 + 0.0254) - 1 ≈ -0.0103 or approximately -1.03%, indicating a negative real rate.

Applying the CAPM formula:

Cost of equity = risk-free rate + beta (market return - risk-free rate) ≈ -1.03% + 1.2 (5% - (-1.03%)) ≈ -1.03% + 1.2 * 6.03% ≈ -1.03% + 7.24% ≈ 6.21%.

Minimum Acceptable Rate of Return

Adding the risk premium to the risk-free rate:

Minimum rate = 7% + 13% = 20%.

This rate sets the threshold for acceptable investment return considering the project’s risk profile.

Conclusion

The comprehensive financial analysis indicates that the decision to acquire the factory, invest in new product lines, and the valuation of stock and options require balancing quantitative measures with qualitative factors. The calculations suggest that some projects may not meet the required thresholds, emphasizing the importance of strategic context in investment decisions. Developing a nuanced understanding of cash flows, risks, and market conditions informs sound investment choices that align with McCormick & Company’s long-term growth objectives.

References

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