McCormick & Company is considering a project that requires an initial investment
ID: 2809625 • Letter: M
Question
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. 8. Find the NPV using the after-tax WACC as the discount rate.
Explanation / Answer
First we calculate the WACC
weight of debt = 100/(100+150) = 0.40
Weight of equity = 150/(100+150) = 0.6
Cost of equity = rf + beta*(Rm - rf) = 5 + 0.9*(13-5) = 12.2%
After tax cost of debt = 8*(1-0.4) = 4.8%
WACC = 0.4*4.8 +0.6*12.2 = 9.24%
WACC = discount rate = 9.24%
Now the NPV is calculated as shown in the table below:
Note:We have not considered the land value becuase land was already avaliable and it was used for this project and after this it will be resued again. So land was not associated with this project.
Sales 63000000 63000000 63000000 63000000 63000000 63000000 Variable cost -19500000 -19500000 -19500000 -19500000 -19500000 -19500000 Fixed cost -500000 -500000 -500000 -500000 -500000 -500000 Depreciation -3429600 -5877600 -4197600 -2997600 -2143200 -2140800 Profit before tax 39570400 37122400 38802400 40002400 40856800 40859200 taxes at 40% -15828160 -14848960 -15520960 -16000960 -16342720 -16343680 Profit after taxes 23742240 22273440 23281440 24001440 24514080 24515520 Add back depreciation 3429600 5877600 4197600 2997600 2143200 2140800 After tax salavge value 6085440 Net cash flow -25000000 27171840 28151040 27479040 26999040 26657280 32741760 NPV at 9.24% $ 99,905,096.99 After tax salavge value Salavge value 8000000 Book Value 3213600 taxable value 4786400 Taxes at 40% -1914560 After tax salaveg value 6085440