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. Should the project be accepted?

Answer 1

Answer:

NPV of the project = $99,371,179.45

Project should be accepted as NPV of the project positive.

Workings:

WACC Calculation:

Cost of equity = Risk free rate + Beta * (Expected market return - Risk free rate)

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

= 12.20%

Before tax cost of debt = 8%

WACC = Cost of equity * Weight of equity + Before tax Cost of debt * (1 - Tax rate) * Weight of debt

= 12.20% * 150 / (150 + 100) + 8% * (1 - 40%) * 100 / (150 + 100)

= 9.24%

WACC = 9.24%

NPV calculation: