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 $500,000. 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.

Year
1	14.29%
2	24.49%
3	17.49%
4	12.49%
5	8.93%
6	8.92%
7	8.93%
8	4.46%

Questions Below

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 loss, 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.

Answer 1

2) Statement showing Depreciation and book value of machine at end of 6 years

Year	Opening balance	Depreciation rate	Depreciation = 24000,000*Depreciation rates	Closing balance
1	24,000,000	14.29%	3429600	20,570,400
2	20,570,400	24.49%	5877600	14,692,800
3	14,692,800	17.49%	4197600	10,495,200
4	10,495,200	12.49%	2997600	7,497,600
5	7,497,600	8.93%	2143200	5,354,400
6	5,354,400	8.92%	2140800	3,213,600
7	3,213,600	8.93%	2143200	1,070,400
8	1,070,400	4.46%	1070400	0

Value of P&M at end of 6 year = 3,213,600$

Selling price of Machine = 8,000,000$

Thus machine will be sold at profit of $ 4,786,400

Tax on profit = 4786400*40% = 1914560$

3) Cost of equity = Risk free rate of return + beta( Expected market return - Risk free rate of return)

=5%+0.9(13%-5%)

=5%+0.9(8%)

=5%+7.2%

=12.2%

Cost of debt = Yield to maturity(1-t)

=8%(1-0.4)

=8%(0.6)

=4.8%

Statement showing WACC

Source of capital	Amount	Weight	K	WACC=Weight*k
Equity	150	60%	12.20%	7.3200%
Debt	100	40%	4.80%	1.9200%
	250			9.2400%

4) Salvage cash flow from new equipment = Selling price less tax

=8000,000-1914560

=6085440$