What are the best estimates of McCormick & Company's capital structure used for the acquisition of new product lines?

File Home Insert Page Layout Formulas Data Review View Help Search Share Comments & Cut Calibri - 11 ~ A" A " ab Wrap Text General Normal Bad Good [) Copy Neutral LIX AutoSum nsert Delete Format Fill AY O Paste Ideas Format Painter BIU Y OvAv EEE EE Merge & Center ~ Conditional Format as Calculation Check Cell Explanatory ... Input Sort & Find & Formatting * Table Clear Filter ~ Select v Clipboard Font Alignment Number Styles Cells Editing Ideas M63 X V Q5 C D H M N O P Q R S T U V W X Z 22 23 The RB Foods acquisition resulted in acquisitions contributing more than one-third of our sales growth in 2017 and is expected 24 to result in acquisitions contributing more than one-third of our sales growth in 2018. 25 As part of your work, you will be asked for a recommendation for the cost of equity. There are three widely accepted 26 methods used to calculate the cost of equity. They are the Capital Asset Pricing Model (CAPM), the Discounted Cash Flow 27 approach (DCF) and the debt rate plus a risk premium of 3% to 5% recommended by one board member. This last is often 28 used by very wealthy investors as a check on the other two methods. 29 30 Questions: Beta x Market 31 1. Even though the CFO expects that it ultimately will not be useful, you have been asked to calculate the cost of equity using Q1 Risk Free | Market Premiu Beta 32 the Capital Asset Pricing Model (CAPM). Yahoo Finance reports Beta as 0.01. Management wants to use the 30 year bond 3% 6% 0.01 0% 33 rate as the risk free rate, arguing that Investors should make long term investments. That rate is 3% today. The expected 34 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 3% CAPM cost of Equity use an expected return of 9% for the average stock. The market risk Premium (RPM) will be 6%. 9% minus 3% = 6%. 35 Calculate the Mccormick & Co cost of equity using the CAPM. The formula is rs = rRF + (RPM) x B. Is is the required return 36 on equity or the Cost of Equity, RF is the risk free rate, RP M is the required stock market return in excess of the risk free rate, 37 and B , (Beta) is the stocks relative risk. B is also described as the estimate of the amount of risk that an individual stock 38 contributes to a well balance portfolio. Q2 D 1 $ 2.38 39 2. The Discounted Cash Flow model (referred to as the Direct Dividend Model in the MBA 620 course materials) is preferred Po $ 135.00 40 by wealthy investors. The formula reduces to Is = (D1 / Po) + g where Is is the required return on equity or the Cost of Equity, D, / P 2% 41 D, is the expected future dividend, Po is the rice of the stock today and g is the expected growth in dividends. The CFO notes 7% 42 that the expected future dividend is $2.38 and the expected growth rate is 7%. Please use $135 per share as the stock price. 9% 43 Calculate the cost of equity Is using the DCF approach. DCF Cost of Equity 44 3. Rick Malcolm is an advisor to a board member who works at a private equity firm. He has told the CFO that sophisticated 45 investors use a quick estimate of the cost of equity. He says that the cost of equity must be above the company's debt rate. Q3 Bond Rate Premium Cost of Equity 46 The estimate is that 3% to 5% should be added to the company's long term interest rates. Mccormick & Company estimates 4% 3% 7% 47 its current borrowing cost at 4%. Make your own estimate of the relative risk of Mccormick & Company. Then calculate the 4% 4% 8% 48 Cost of equity, Is using this own debt plus a 3% to 5% formula. 4% 5% 9% 49 50 4. Pick your own best estimate of Mccormick & Company cost of equity and tell why you made the choice. Q4 Short Term borrwings 560 51 5. Calculate the Weighted Average Cost of Capital (WACC) for Mccormick and Company using the formula Current portion of long te 33.5 52 WACC = Wo Ro (1-T) + Ws rS and Wo = Value of debt / Value of debt plus value of equity; Ws = Value of Stock Equity / Value Long term debt $4,052.90 Total Capital 53 of Debt Plus Value of Equity. For ease, the CFO says to use book value of Debt and the market Value of Equity. On February Total $4,696.40 Market Cap Equity $17,500.00 $22,196.40 54 26, 2019 the market Value of Equity (or Market Cap) in Yahoo was $17.5 billion. Use the 2018 10-K Financial Statements filed 55 January 25, 2019 and look on the Balance sheet to see the total of Short term borrowings, Current portion of long term debt Weight 21% 78.80% 56 and Long term debt. Use 4% for the cost of debt. Use 27.5% as the tax rate - a combination of federal and state income tax. Cost of Debt 4% 57 Tax rate 28% Cost of Equity 8.00% 58 5. Recognize that Finance Theory tells us to use the WACC for the discount rate for capital budgeting. The past discount rate 59 was 7%. Do you recommend that Mccormick change its discount rate. If so what rate do you recommend? If not, why not? After tax cost of debt 3% Debt term Equity Term 60 1% 0.06304 6.92% 61File Home Insert Page Layout Formulas Data Review View Help Search 15 Share Comments & Cut CB) Copy Calibri 11 ~ A" A = = =2%% ab Wrap Text General Normal Bad Good Neutral AutoSum AY O Paste Format Painter BIU~ ~ A~ EEE EE Merge & Center v $ ~ % 2 00 Conditional Format as Calculation Check Cell Fill Insert Delete Format Formatting Table v Explanatory ... Input Clear Sort & Find & Ideas Filter ~ Select Clipboard Font Alignment Number Styles Cells Editing Ideas F50 X V M N O P Q R U W Z AA AB AC AD AE 40 AF AG AH Al AJ Rate 79% 41 42 Q3 NPV $716.88 43 Cash Flow (380.00) IRR 18% Table 3 Net Present Value $336.88 Q4 A B D Cash Tax in $Millions Cash from outflow , Taxable 27.5% rate in Revenue in expenses in Depreciation in Income in $ years 1, 2, 3 and After tax Cash Flow In Year $Millions $Millions $Millions Millions 50% there after $Millions Year Cash Flow $1,800 $1, 762.56 $50.02 -$12.57 -$3.46 $40.90 -380 $1,900 $1,860.48 $85.72 $46.20 $12.70 $52.2 $40.90 $2,000 $1,958.40 $61.22 $19.62 $5.39 $46.99 2,100 $52.22 $2,056.32 $43.72 -$0.04 0.02 $43.70 $46.99 2,200 $2,154.24 $31.26 $2,252.16 $14.50 $7.25 $2,300 $31.22 $16.62 $8.31 $38.51 $43.70 $2,400 $39.53 $2,350.08 $38.51 $31.26 $18.67 $9.33 2,500 $40.59 $2,448.00 $39.53 $15.61 $36.39 $2,60 $2,545.92 $18.20 $33.81 $54.08 $40.59 $2, 700 $2,643.84 $27.04 $27.04 $56.16 $33.81 $28.08 $27.04 $2,600 $2,545.92 $27.04 $0.00 $54.08 $2,500 $2,448.00 $27.04 $27.04 $28.08 $2,400 $52.00 $26.00 $24.96 $2,350.08 $27.04 $49.92 $24.96 $2, 200 $24.96 $2,154.24 $26.00 $22.88 $2,000 $1,958.40 $45.76 $22.8 $41.60 $24.96 $20.80 $1,800 $20.80 $1,762.56 14 $22.88 $37.44 $18.72 $18.72 $1,500 $1,468.80 $31.20 $20.80 $15.60 $1, 200 $15.60 16 $18.72 $800 $1, 175.04 $24.96 $783.36 $12.4 $12.48 $15.60 $16.64 $400 $8.32 $8.32 $391.68 $12.48 $8.32 $4.16 $4.16 $8.32 $4.16 Q5 NPV Function $352.77 Cash flow zero -$380.00 IRR 6% Net Present Value -$27.23 Q6 The IRR is low. The project should not be accepted The chances if tge project resulting in a positive NPR is not likely. 6 AM 2019 Instructions Cost of Capital Capital Budgeting +File Home Insert Page Layout Formulas Data Review View Help Search Share Comments & Cut LOBcopy Calibri 11 A A ab Wrap Text General Norma Bad Good Neutral _ AutoSum ~ Paste AY O Format Painter BIU Y MAY E Merge & Center $ ~ % " Conditional Format as |Calculation Check Cell Formatting ~ Table v Explanatory ... Input usert Delete Format Fill Clear ~ Sort & Find & Ideas Clipboard Font Filter ~ Select v Alignment Number Styles Cells Editing Ideas F50 X V M N Q R S U V 1 Table 1 W X Z AB AC AD AE AF AG AH Al AJ . W N MACRS Depreciation $350 Year 7 Year class Depreciation Year 21 14.29% $50.02 Equipment $ (350.00) 24.49% $85.72 Land 17.49% $61.22 $ (14.00) $ 40.00 Accounts Receivable 12.49% $43.72 $ (17.00) $ 17.00 Inventory 8.93% $ (14.00) $ 14.00 $31.26 Accounts Payable $ 15.00 $ (15.00) 8.92% Cash Flow 0 $ (380.00) $ 56.00 8.93% $31.26 4.46% $15.61 $350.00 Table 2 A D Cash Cash from outflow, Taxable Revenue in expenses in Depreciation in Income in $ Year $Millions Tax in $Millions After tax Cash Flow In SMillions $Millions Millions 27.5% rate $Millions Q2 Year $1,80 $1,728 $50.02 After tax Cash Flow In $Millions $21.9 $6.05 $65.95 $1,90 $1,824 $85.72 o$ (380.00) -$9.72 $2.67 $78.67 $2,000 $1,920 $61.2 $18.79 $5.17 $2,100 $2,01 $43.72 $40.2 $11.08 $72.92 $2,200 $2,112 $31.26 $56.75 $15.60 $72.40 WNK 65.95 78.67 74.83 4 72.92 $2,300 $2,208 $31.22 $60.78 $16.71 $74.20 $2,400 $2,304 $31.26 $64.75 $17.80 5 72.40 $2,500 $2,40 $78.20 $15.61 $84.39 $ 75.29 $2,600 $2,496 $104.00 78.20 $2, 700 $28.60 $75.40 76.79 $108.00 $29.70 8 $2,600 $78.30 $2,496 $104.00 75.40 $2,500 $28.60 9 9 $75.40 $2,400 10 $ 78.30 $100.0 $2,400 $27.50 $72.50 $2,304 $96.00 11 $ 75.40 $2,200 $26.40 $69.60 $2,112 $88.00 12 $ $24.20 72.50 $63.80 $2,000 $1,920 13 $ 69.60 $80.00 $22.00 $58.0 14 $ 63.80 17 $1,800 $1,728 $72.00 $1,500 $19.80 $52.20 $1,440 15 $ 58.00 18 $60.00 $16.50 $43.50 $1, 200 $1,152 $48.0 $13.20 $34.80 16 $ 52.20 19 20 $800 $768 17 $ 43.50 $400 $384 $32.0 $8.80 $23.20 18 $ 34.80 $16.00 $4.40 $11.60 19 $ 23.20 20 $ 11.60 Rate 7% 11:56 AM Q3 NPV $716.88 9/3/2019 Instructions Cost of Capital Capital Budgeting +