Question

I got the answers for 1 and 2, but I am confused on what I am supposed to do for questions 3 to 6. I know that the NPV you need the discount rate, but I do not sure what the discount rate would be.

Details of McCormick Plant Proposal As you know from Project 4, McCormick & Company is considering a project that requires an initial investment of $350 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 $14 million. You have been asked to refine your work to include the correct tax impact of depreciation, and the cash flow impact of working capital on the capital budget evaluation. The investment will be depreciated as a modified accelerated cost recovery system (MACRS) seven-year class asset. The correct depreciation table is included at the right. The company will need to finance some of the cash to fund $17 million in receivables and $14 million in Inventory starting at year zero. The company expects vendors to give free credit on purchases of $15 million (accounts Payable). Add the net cash outflow for working capital to the cash outflow for the plant, equipment and land in year zero. The $17 million for receivables and the $14 million for Inventory are cash outflows. The $15 million for receivables is a cash inflow. Assume that this net working capital is recovered as a cash inflow in year 21. The company still estimates revenues and expenses the same as it did in Project 4. See Table 2 at the right. The company now estimates that it can sell the land in year 21 for $40 million. It will also recover the cash spent on working capital in year 21.

Answer 1

YEAR Cash from Cash Revenue in $ outflow,expense Millions sin $ Millions Depreciation in $ Millions 1,728.00 -2.67 50.02 85.72 61.22 43.72 31.26 31.22 31.26 15.61 -366.00 1,800.00 1,900.00 2,000.00 2,100.00 2,200.00 2,300.00 2,400.00 2,500.00 2,600.00 2,700.00 2,600.00 2,500.00 2,400.00 2,200.00 2,000.00 1,800.00 1,500.00 1,200.00 Taxable Income in $ Millions -366.00 21.98 -9.72 18.78 40.28 56.74 60.78 64.74 84.39 104.00 Tax in $ After tax Discount PV OF Millions cash flow Rate CASH 27.5% in $ 19.07% FLOWS Rate Millions -366.00 -366.00 6.04 65.96 0.8398 55.39 78.67 0.7053 55.49 5.16 74.84 0.5923 44.33 11.08 72.92 0.4974 36.27 15.60 72.40 0.4177 30.24 16.71 75.29 0.3508 26.41 17.80 78.201 0.2946 23.04 23.21 76.79 0.2474 19.00 28.60 75.40 0.2078 15.67 29.70 78.30 0.1745 13.66 28.60 75.40 0.1466 11.05 27.50 72.50 0.1231 8.92 26.40 69.60 0.1034 7.20 24.20 63.80 0.0868 5.54 22.00 58.00 0.0729 4.23 19.80 52.20 0.0612 3.19 16.50 43.50 0.0514 2.24 13.20 34.80 0.0432 1.50 8.80 23.20 0.0363 0.84 4.40 11.601 0.0305 0.35 56.00 0.0256 1.43 NPV 0.00 IRR = 19.07% 1,824.00 1,920.00 2,016.00 2,112.00 2,208.00 2,304.00 2,400.00 2,496.00 2,592.00 2,496.00 2,400.00 2,304.00 2,112.00 1,920.00 1,728.00 1,440.00 1,152.00 768.00 384.00 108.00 104.00 100.00 96.00 88.00 80.00 72.00 60.00 800.00 400.00 48.00 32.00 16.00 21 56.00 56.00

No Cost of Capital is given in the Question

Hence we have to find out IRR

At IRR NPV is always equal to Zero

IRR is calculated by using Trial and Error Method

till NPV is equal to Zero

As IRR is 19.07 % the project can be accepted if it is less than Cost of the Capital of the Company

As IRR is 7.014 % in the second case it has to be compared with Cost of Capital of the company and decision has to be made

YEAR Cash from Cash Revenue in $ outflow,expense Millions sin $ Millions Depreciation in $ Millions 50.02 85.72 61.22 43.72 31.26 31.22 31.26 15.61 -366.00 1,800.00 1,900.00 2,000.00 2,100.00 2,200.00 2,300.00 2,400.00 2,500.00 2,600.00 2,700.00 2,600.00 2,500.00 2,400.00 2,200.00 2,000.00 1,800.00 1,500.00 1,200.00 800.00 400.00 56.00 1,762.56 1,860.48 1,958.40 2,056.32 2,154.24 2,252.16 2,350.08 2,448.00 2,545.92 2,643.84 2,545.92 2,448.00 2,350.08 2,154.24 1,958.40 1,762.56 1,468.80 1,175.04 783.36 391.68 Taxable Income in $ Millions -366.00 -12.58 -46.20 -19.62 -0.04 14.50 16.62 18.66 36.39 54.08 56.16 54.08 52.00 49.92 45.76 41.60 37.44 31.20 24.96 16.64 8.32 56.00 Tax in $ After tax Discount PV OF Millions cash flow Rate CASH 27.5% in $ 7.014% FLOWS Rate Millions -366.00 -366.00 -3.46 40.90 0.9345 38.22 -12.71 52.23 0.8733 45.61 -5.40 47.00 0.8161 38.36 -0.02 43.70 0.7626 33.33 7.25 38.51 0.7126 27.44 8.31 39.53 0.6659 26.32 9.33 40.59 0.6223 25.26 18.20 33.80 0.5815 19.65 27.04 27.04 0.5434 14.69 28.08 28.08 0.5078 14.26 27.04 27.04 0.4745 12.83 26.00 26.00 0.4434 11.53 24.96 24.96 0.4143 10.34 22.88 22.88 0.3871 8.86 20.80 20.80 0.36177.52 18.72 18.72 0.338 6.33 15.60 15.60 0.3158 4.93 12.48 12.48 0.2951 3.68 8.32 8.32 0.2758 2.29 4.16 4.16 0.2577 1.07 56.00 0.2408 13.48 NPV 0.02 IRR = 7.014% 12 14 15 16 17 18 19 20 21