1. You have been asked to calculate the cost of equity using the Capital Asset Pricing Model (CAPM). The CFO estimates the Beta as 0.90. Management wants to use the 30 year bond rate as the risk free rate, arguing that Investors should make long term investments; that rate is 3% today. The expected return on the stock market as a whole has been estimated to be 7%, 10% and 12% by various studies. The CFO asks that you use an expected return of 9% for the average stock. The market risk Premium (RPM) will be 6%. 9% minus 3% = 6%. Calculate the cost of equity (Rs) using the CAPM. The formula is Rs = rRF + (RPM ) x . Rs is the required return on equity or the Cost of Equity, rRF is the risk free rate, RP M is the required stock market return in excess of the risk free rate, and , (Beta) is the stocks relative risk. is also described as the estimate of the amount of risk that an individual stock contributes to a well balance portfolio.
Information from McCormick Your task is to make an estimate of McCormick & Company's Weighted Average cost of Capital (WACC) to use as the discount rate for evaluating capital projects, such as the one in the next tab. The CFO plans to borrow a portion of the required 5350 milion initial investment for this project using 20 year bonds. For most of the past 10 years, the company has used as the discount rate. This was based on a study of the company's WACC in early 2010. Interest rates have risen since the last study when the McCormick & Corate average interest rate was 3. We will use 4% today. Also, there has been a change in the weights between debt and equity in the overall capital structure since 2010. The most significant change was the acquisition of Re Food. It is the main reason for this study. Here is what our MD&A reported about that acquisition On August 17, 2017, we completed the acqubition of Reckitt Bencker's Food Division" Foods from Reckitt Benckiser Group ple. The purchase price was approximately $4.2 billion, ne of acquired cash. The acquisition was funded through our issuance of approximately 6.35 million shares of common stock non-voting see note 13 of the financial statements and through www borrowings comprised of sewar unsecured notes and pre-payable term land see note 5 of the financial statements. The acquired market-leading brands of RB Foods include French's, Frank's Red Hor" and Cartemen's which are a natural strategic fit with our robust global branded flower portfolio. We believe that these addition move us to a leading position in the attractive L.S. condiments category and provide significant international growth opportunities for our consumer and industrial segments. The RS Food acquisition resulted in acquisitions contributing more than one-chird of our sales growth in 2017 and has expected to result in acquisitions contributing more than one-third of our sales growth in 2018 As part of your work, you will be asked for a recommendation for the cost of equity. There are three widely accepted methods used to calculate the cost of equity. They are the Capital Asses Pricing Model (CAPM), the Discounted Cash Flow approach (DCF) and the debt rate plus a risk premium of 3% 60 % recommended by one board member. This last is often used by very wealthy investors as a check on the other two methods. Your recommendation for the cost of equity will be necessary so you can undertake the calculation estimating the WACC. Questions 1. You have been asked to calculate the cost of equity using the Capital Asset Pricing Model CAPM). The CFO estimates the Busa as 0.80. Management wants to use the 30 year bond rate as the risk free ate, arguing that investors should make long term investments that rate is today. The expected return on the stock market as a whole has been estimated to be 7%, 10% and 12% by various studies. The CFO asks that you use an expected return of 9% for the average stock. The market risk Premium RP will be 6.9 minus 3%-5% Calculate the cost of equity) using the CAPM. The formula is Rs - RFRP Rs is the required retum on equity or the cost of Equity, res is the risk free rate, RP is the required stock market return in excess of the risk free rate, and Beta is the stocks relative risk. I also described as the estimate of the amount of risk that an individual stock contributes to a well balance portfolio 2. The Discounted Cash Flow model is referred to as the Direct Dividend Model in the MBA 620 course materials. The formula reduces to Rs - 10 / P1+ where Rs is the required return on equity or the Cost of Equity, D, is the expected future dividend. Pe is the price of the stock today and is the expected growth in dividends. The CFD notes that the expected future dividend is $2.38 and the expected growth rate is 7%. For this calculation, please use the March 17, 2020 closing price of $138.70 per share. Calculate the cost of equity (Ra) using the DCF approach 3. Cristina Flores is an advisor to a board member who works at a private equity firm. She has told the CFO thus sophisticated investors use a quick estimate of the cost of equity. She says that the cost of equity must logicaly be higher than the company's debit rate. The estimate is that 3% to 5% should be added to the company's long term interest rates. McCormick Company estimates its current borrowing cost ar 4%. Make your own estimate of the relative risk of McCormick & Company. Then, calculate the cost of equity (Ra) using this "ewn debt plus 3% to 5x" formula 4. Calculate the weighted Average cost of Capital (WACC) for McCormick and Company using the formula WACC - (WxRg 3 (1-1)] + [Ws * RS! Note that Rs - the cost of equity Rd the cost of debt The tax rate W.- Value of debt / (Value of debt plus value of equity Ws - Value of equity / (Value of debt plus value of equity) Note that the weight of debt plus the weight of equity must total to 100%, as there are only two components in the capital structure." In order to estimate the weights of debt and equity in the total capital structure, the CFO suggests using the book value of debt and the market value of equity. To determine the book value of debt, use data from the year end November 2019 McCormick 10-6. Look on the Balance sheet and add the following -- Short term borrowings, Current portion of long term debil, and long term debit. To determine the market value of equity, use the following data: on March 17, 2020 the market value of equity for Market Cap") for McCormick (MKC - as found on Yahoo Finance - was $18.42 bilion. Use 4. for the cost of debt. Use 27.5% as the tax rate an estimate of the combination of federal and state income tax rates. Make your own best estimate of the cost of equity based on your work in questions 1, 2, and a Anruer Rustian Belous #1 Rirk Froo Rato Market Premium Beta Botax Market Premium Rirk Freerate CAPM cart of Equity Information from McCormick Your task is to make an estimate of McCormick & Company's Weighted Average cost of Capital (WACC) to use as the discount rate for evaluating capital projects, such as the one in the next tab. The CFO plans to borrow a portion of the required 5350 milion initial investment for this project using 20 year bonds. For most of the past 10 years, the company has used as the discount rate. This was based on a study of the company's WACC in early 2010. Interest rates have risen since the last study when the McCormick & Corate average interest rate was 3. We will use 4% today. Also, there has been a change in the weights between debt and equity in the overall capital structure since 2010. The most significant change was the acquisition of Re Food. It is the main reason for this study. Here is what our MD&A reported about that acquisition On August 17, 2017, we completed the acqubition of Reckitt Bencker's Food Division" Foods from Reckitt Benckiser Group ple. The purchase price was approximately $4.2 billion, ne of acquired cash. The acquisition was funded through our issuance of approximately 6.35 million shares of common stock non-voting see note 13 of the financial statements and through www borrowings comprised of sewar unsecured notes and pre-payable term land see note 5 of the financial statements. The acquired market-leading brands of RB Foods include French's, Frank's Red Hor" and Cartemen's which are a natural strategic fit with our robust global branded flower portfolio. We believe that these addition move us to a leading position in the attractive L.S. condiments category and provide significant international growth opportunities for our consumer and industrial segments. The RS Food acquisition resulted in acquisitions contributing more than one-chird of our sales growth in 2017 and has expected to result in acquisitions contributing more than one-third of our sales growth in 2018 As part of your work, you will be asked for a recommendation for the cost of equity. There are three widely accepted methods used to calculate the cost of equity. They are the Capital Asses Pricing Model (CAPM), the Discounted Cash Flow approach (DCF) and the debt rate plus a risk premium of 3% 60 % recommended by one board member. This last is often used by very wealthy investors as a check on the other two methods. Your recommendation for the cost of equity will be necessary so you can undertake the calculation estimating the WACC. Questions 1. You have been asked to calculate the cost of equity using the Capital Asset Pricing Model CAPM). The CFO estimates the Busa as 0.80. Management wants to use the 30 year bond rate as the risk free ate, arguing that investors should make long term investments that rate is today. The expected return on the stock market as a whole has been estimated to be 7%, 10% and 12% by various studies. The CFO asks that you use an expected return of 9% for the average stock. The market risk Premium RP will be 6.9 minus 3%-5% Calculate the cost of equity) using the CAPM. The formula is Rs - RFRP Rs is the required retum on equity or the cost of Equity, res is the risk free rate, RP is the required stock market return in excess of the risk free rate, and Beta is the stocks relative risk. I also described as the estimate of the amount of risk that an individual stock contributes to a well balance portfolio 2. The Discounted Cash Flow model is referred to as the Direct Dividend Model in the MBA 620 course materials. The formula reduces to Rs - 10 / P1+ where Rs is the required return on equity or the Cost of Equity, D, is the expected future dividend. Pe is the price of the stock today and is the expected growth in dividends. The CFD notes that the expected future dividend is $2.38 and the expected growth rate is 7%. For this calculation, please use the March 17, 2020 closing price of $138.70 per share. Calculate the cost of equity (Ra) using the DCF approach 3. Cristina Flores is an advisor to a board member who works at a private equity firm. She has told the CFO thus sophisticated investors use a quick estimate of the cost of equity. She says that the cost of equity must logicaly be higher than the company's debit rate. The estimate is that 3% to 5% should be added to the company's long term interest rates. McCormick Company estimates its current borrowing cost ar 4%. Make your own estimate of the relative risk of McCormick & Company. Then, calculate the cost of equity (Ra) using this "ewn debt plus 3% to 5x" formula 4. Calculate the weighted Average cost of Capital (WACC) for McCormick and Company using the formula WACC - (WxRg 3 (1-1)] + [Ws * RS! Note that Rs - the cost of equity Rd the cost of debt The tax rate W.- Value of debt / (Value of debt plus value of equity Ws - Value of equity / (Value of debt plus value of equity) Note that the weight of debt plus the weight of equity must total to 100%, as there are only two components in the capital structure." In order to estimate the weights of debt and equity in the total capital structure, the CFO suggests using the book value of debt and the market value of equity. To determine the book value of debt, use data from the year end November 2019 McCormick 10-6. Look on the Balance sheet and add the following -- Short term borrowings, Current portion of long term debil, and long term debit. To determine the market value of equity, use the following data: on March 17, 2020 the market value of equity for Market Cap") for McCormick (MKC - as found on Yahoo Finance - was $18.42 bilion. Use 4. for the cost of debt. Use 27.5% as the tax rate an estimate of the combination of federal and state income tax rates. Make your own best estimate of the cost of equity based on your work in questions 1, 2, and a Anruer Rustian Belous #1 Rirk Froo Rato Market Premium Beta Botax Market Premium Rirk Freerate CAPM cart of Equity
