Question

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 $500,000. 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.

What will be the tax depreciation each year?

PLEASE show how you calculated the value of the plant and equipment purposes in six years.

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 loss, and what will the tax effect be?

Answer 1

Given Information	Value	Units
PP&E	24	$mn
Company Land	4.3	$mn
COGS/unit	150	$/unit
Revenue/Unit	420	$/unit
Annual Fixed Cost	500,000	$
Sales	150,000	$/Year
Debt	100	$mn
Equity	150	$mn
Cost Of Debt	8%
Beta	0.9
Market Return	13%
Rf	5%
Tax Rate	40%
Modified accelerated cost recovery system (MACRS)
Year 1 Depreciatio n=	Cost * 1/Life of Asset * Depreciation rate * Depreciation Convention
Where,
Cost=	24	Cost of the asset
Life of Asset =	7	Useful life for which asset can be employed
Depreciation Rate =	200%	100%, 150% or 200% depending on asset class - we can use 200% for PP&E
Depreciation convention-	1	Depending at time of asset purchase - for our case its start oft the year so - value = 1
Subsequent Year Depreciation=	(Cost - Accumulated depreciation)*1/Life of Asset * depreciation rate * depreciation convention
Year	PP&E Value = (Cost - Accumulated Depreciation)	Depreciation formula using MACRS system	Depreciation using MACRS system	Depreciation using straight line	Tax Deprecaition Applicable = Greater of MACRS vs Straight Line
0	24.000	=24*1/7*200%	6.86	3.43	6.86
1	17.143	=17.143*1/7*200%	4.90	2.86	4.90
2	12.245	=12.245*1/7*200%	3.50	2.45	3.50
3	8.746	=8.746*1/7*200%	2.50	2.19	2.50
4	6.247	=6.247*1/7*200%	1.78	2.08	2.08
5	4.165	=4.462*1/7*200%	1.19	2.08	2.08
6	2.082	=12.245*1/7*200%	0.59	2.08	2.08
So, Value of PP&E at end of year 6 will be 2.082
Expected Sales Value at end of 6 year is 8mn
So, PP&E will be sold at a pre tax gain of	=8-2.082	5.918
Post Tax gain on sale of PP&E	=5.918*(1-40%)	3.5508