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.

Questions:

1. What will be the tax depreciation each year? Note: the total deprecation of tax purposes will still be $350 million if your calculations are correct.

2. Create an after-tax cash flow timeline similar to the one you did in Project 4. 3. Calculate the new NPV and IRR. Should the Project be accepted? The CFO thinks that the likely NPV and IRR will be close to the numbers that you calculated in Project 4.

The following questions will be used to estimate risk. Please use Table 3 to calculate cash flow.

4. The controller is worried about tax increases and estimates that the tax rate with be raised to 50% (federal and Maryland state) in year 4. Also there is a concern that expenses are understated. He asks, "What would happen to the NPV calculation if the cash tax expenses come in 2% higher than estimated and the tax rate increases to 50% in year 4?" This will allow a subjective evaluation of the project risk. Calculate a new cash flow time line with cash expenses 10% higher than those in Table 2 and with a 50% tax rate. Use Table 3 5. What would be the net present value, NPV in this "worst case" cash flow? What will be the IRR?

6. Should the project be accepted? Discuss the risk and the reward to McCormick.