Reference no: EM132306581

Instructions

To complete this workbook, answer the questions on each worksheet in the space provided.

1. 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 percent, 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 relevent 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 relevent annual expected cash flows (C1) associated with the puchase 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 relevent annual expected cash flows represents funds used to pay operating expenses for subsequent years. All estimated relevent 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?

2. 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 by 8.5 percent 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 eight 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 percent, the 10-year government bonds rate is 2.5 percent, and the inflation rate is 2.54 percent. What is the real risk-free rate? Then, assume a beta of 1.2 and a market return of 5 percent. 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?

3. Questions

1. Liz is retiring from the US 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 percent.  How much will she get as an annuity monthly payment?  Should Liz take the annuity or move the money to the IRA? The tax regulations require that she take out 4 percent of the amount each year.

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 percent annual rate or a 15 year mortgage at 4 percent.

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?