Question

McCormick & Company is considering a project that requires an initial investment of $24millionto build a new plant and purchase equipment. The investment will be depreciated as a modified acceleratedcost 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 $4.3million.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 $500,000. Unit sales are expected to be $150,000each year for the next sixyears, at which time the project will be abandoned. At that time, the plant and equipment is expected to be worth $8million(before tax) and the land is expected to be worth $5.4million(after tax).  To supplement the production process, the company will need to purchase $1millionworth of inventory. That inventory will be depleted during the final year of the project. The company has $100millionof debt outstanding with a yieldtomaturity of 8percent, and has $150millionof equity outstanding with a beta of 0.9. The expected market return is 13percent,and the risk-free rate is 5percent.The company's marginal tax rate is 40percent.

6. Create an after-tax cash flow timeline.

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

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.  

Answer 1