Instructions

To complete this workbook, answer the questions on each worksheet in the space
provided.
 Information from McCormick
1. As of today, McCormick's market capitalization (E) is $14,237,510,000. Market value of equity (E), also known as
calculated using the following equation: Market Cap = Share Price x Shares Outstanding.
2. McCormick's book value of debt is $3,237,150,000. Book value of debt (D) is calculated as follows: Book Value of
Average of Current Portion of Long-Term Debt + Last Two-Year Average of Long-Term Debt & Capital Lease Obligati

3. Cost of Equity = Risk-Free Rate of Return + Beta of Asset x (Expected Return of the Market - Risk-Free Rate of Ret
Risk-free rate of return = 2.82 percent.
Beta = 0.30.
Market premium = (Expected Return of the Market - Risk-Free Rate of Return) = 6 percent

4. Cost of Debt = Last Fiscal Year End Interest Expense / Book Value of Debt (D). McCormick's last fiscal year end in
million.

5. Use the effective tax rate of 25.705 percent.

Questions Use this area to show your work using Excel.

1. Find the weight of equity = E / (E + D). 81.48%

2. Find the weight of debt = D / (E + D). 18.52%

3. Find the cost of equity. Risk-Free Rate of Return + Beta of Asset x (Expected Return of the Market - Risk-Fre
2.82+0.30(6)=2.82+1.80=4.62%
4. Find the cost of debt. Last Fiscal Year End Interest Expense / Book Value of Debt (D)
cost of debt 2.956%
After tax cost of debt 1.774%
5. Find the weighted average cost of capital (WACC). (D/D+E)*Kd+(E/K+D)*ke
4.09%
quity (E), also known as market cap, is

as follows: Book Value of Debt = Last Two-Year

& Capital Lease Obligation.

et - Risk-Free Rate of Return)

ent

k's last fiscal year end interest expense is $95.7

of the Market - Risk-Free Rate of Return)

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?

Questions

1. What will be the tax depreciation each year?

2. What will be the value of the plant and equipment for tax purposes in year six? Will it be sold for a gain or a los
and what will the tax effect be?

3. What is the weighted average cost of capital (WACC)?

4. What is the salvage cash flow of the new equipment? Include the income tax effect.

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 are 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.
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.
 $24 million to build a new
celerated cost recovery system
's land, which has a current,

20 each. There are annual fixed

t six years, at which time the
worth $8 million (before tax)

n worth of inventory. That

0 million of debt outstanding
h a beta of 0.9. The expected
nal tax rate is 40 percent.

Use the area below to show your work using Excel.

Year
MACRS depreciation rate
Will it be sold for a gain or a loss, Initial investment value
Depreciation Tax (a)
Marginal tax rate
Tax depreciation
ct. Deprecitiable Value
Salvage value
Tax on salvage value
Salvage value after tax

2 Value of plant and equipment for tax purposes in year six (b)
There will be gain on the sale of the plant and equipment
an opportunity cost and must
can be sold in six years for $5.4 3 WACC
cost of equity=
After tax cost of debt=
WACC
4 Salvage cash of the plant and equipment

cision rule.
5. operating cash flow

6. After-tax flow time line

7. Expected cash flow at the end of year six

8. NPV
9. IRR
The project should be accepted because it has a positive NPV and higher IRR of 93% which is g
investment project.
work using Excel.
0 1
14.29%
24 24,000,000
3,429,600
40%
1,371,840
20,570,400

r tax purposes in year six (b) 8,000,000

he plant and equipment 1,914,560

RF+beta(EMR-RF)=5%+0.9(13%-5%)=5%+7.2%=12.2%
Int(1-T)=8%(1-40)=4.8%
(D/D+E)*Kd+(E/K+D)*Ke=(100/250)*4.8%+(150/250)*12.2%=9.24%
Salvage value-tax component $ 6,085,440
Figures in USD millions
Investment $ (24.00)
Land-after-tax value $ (4.30)
Increase $ (1.00)
Year 1
Sales 63,000,000
cost 20,000,000
Operating profit 43,000,000
Less depreciation 3,429,600
 Operaring profit after depreciation 39,570,400
Marginal tax @ 40% 15,828,160
Profit after tax 23,742,240
Add back depreciation 3,429,600
Add change in working capital
Operating cash flow -25,000,000 27,171,840
Add salvage value
After tax flow time line line 27,171,840
Add opportunity cost -4,300,000
Total expected cash flow $ (29,300,000.00) 27,171,840
Cash flow after year six $ 146,300,000.00
WACC 9.24% 0.915415598681802
Present value per year 24,873,526.18
Total present value 128,671,179.45
Net Present value $ 99,371,179.45
IRR 93%
ecause it has a positive NPV and higher IRR of 93% which is greater than the WACC of 9.24%. NPV provides a reliable decision rule while IR
 All figures are in USD
2 3 4 5
24.49% 17.49% 12.49% 8.93%
24,000,000 24,000,000 24,000,000 24,000,000
5,877,600 4,197,600 2,997,600 2,143,200
40% 40% 40% 40%
2,351,040 1,679,040 1,199,040 857,280
14,692,800 10,495,200 7,497,600 5,354,400

2 3 4 5
63,000,000 63,000,000 63,000,000 63,000,000
20,000,000 20,000,000 20,000,000 20,000,000
43,000,000 43,000,000 43,000,000 43,000,000
5,877,600 4,197,600 2,997,600 2,143,200
 37,122,400 38,802,400 40,002,400 40,856,800
14,848,960 15,520,960 16,000,960 16,342,720
22,273,440 23,281,440 24,001,440 24,514,080
5,877,600 4,197,600 2,997,600 2,143,200

28,151,040 27,479,040 26,999,040 26,657,280

28,151,040 27,479,040 26,999,040 26,657,280

28,151,040 27,479,040 26,999,040 26,657,280

0.837985718309961 0.767105198013513 0.702220064091462 0.642823200376658

23,590,169.48 21,079,314.42 18,959,267.60 17,135,918.04

ble decision rule while IRR presumes that the cash flows are reinvested at IRR. NPV gives the overal value created by taking the
 Millions
6
8.92%
24,000,000
2,140,800
40%
856,320
3,213,600
8,000,000
1,914,560
6,085,440

5.4
1
6
63,000,000
20,000,000
43,000,000
2,140,800
 40,859,200
16,343,680
24,515,520
2,140,800
1,000,000
27656320
6,085,440
33741760
5,400,000
39141760

0.58845038481935
23,032,983.73

value created by taking the