Question

I have the answers for 1 through 3, but I am stomped on answers for 4 to 6.

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. Interest rates have risen and the CFO plans to borrow $350 million using the 20 year bond that you recommended in Project 4. For most of the past 10 years the company has used 7% as the discount rate. This was based on study of the company's WACC in early 2010. Interest rates have risen since the last study when the McCormick & Co rate average interest rate was 3%. We will use 4% today. Also, there has been a change in the weights between debt and equity. The most significant change was the acquisition of RB Foods. 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 acquisition of Reckitt Benckiser's Food Division ("RB Foods") from Reckitt Benckiser Group plc. The purchase price was approximately $4.2 billion, net 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 new borrowings comprised of senior unsecured notes and pre-payable term loans (see note 6 of the financial statements). The acquired market-leading brands of RB Foods include French's®, Frank's Red Hot and Cattlemen's®, which are a natural strategic fit with our robust global branded flavor portfolio. We believe that these additions move us to a leading position in the attractive U.S. condiments category and provide significant international growth opportunities for our consumer and industrial segments. The RB Foods acquisition resulted in acquisitions contributing more than one-third of our sales growth in 2017 and is 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 Asset Pricing Model (CAPM), the Discounted Cash Flow approach (DCF) and the debt rate plus a risk premium of 3% to 5% recommended by one board member. This last is often used by very wealthy investors as a check on the other two methods.

Answer 1

Solution for 4.
According to me we should use CAPM cost of equity because this takes in consideration both systematic and non systematic risk. From an investors point of view all the risk are considered.

In DCF it only considers the price and growth which are company specific however market information is not considered

In the advisors suggested rate it is a rough estimate and could have personal bias.

So I will select CAPM cost of equity

Solution for 5.

B C 3% 0.01 6% 3.06% =B3+(B4%B5) 2.38 135 7% 8.76% =(B9/B10)+B11 2 Using CAPM 3 Risk free 4 Beta 5 Risk premium 6 Ke 7 8 DCF 9 D1 10 PO 11 g 12 Ke 13 14 WACC 15 Market value of equity 16 Debt 17 Debt 18 Equity + debt 19 Weight of equity 20 Weight of Debt 21 Cost of debt 22 Tax rate 23 Cost of Equity 24 WACC 25 figures from Balance sheet converted to billion 17.50 Bn 4696.40 mn 4.70 Bn 22.20 Bn 78.84% 21.16% 4% Given 27.50% Given 3.06% 3.03% =B15/B18 =B17/18 =B6 =B20*(B21*(1-B22))+B19*B23

Balance sheet from company website

Not secure west.mobular.net/west/7/3558/5067/ reneurs' Org... e Reset Password O Outlook Web App G Google eazypay | Search, Vi... Customer Portal P Water Bill Payment... EO Goa Retreat India vs England I = Menu « < 53 > >> Search CONSOLIDATED BALANCE SHEETS 2018 2017 $ $ 96.6 518.1 786.3 78.9 186.8 555.1 793.3 81.8 1,479.9 985.1 4,527.9 2,873.3 390.2 at November 30 millions) Assets Cash and cash equivalents Trade accounts receivable, less allowances of $6.4 for 2018 and $6.6 for 2017 Inventories Prepaid expenses and other current assets Total current assets Property, plant and equipment, net Goodwill Intangible assets, net Investments and other assets Total assets Liabilities Short-term borrowings Current portion of long-term debt Trade accounts payable Other accrued liabilities Total current liabilities Long-term debt Deferred taxes Other long-term liabilities Total liabilities 1,617.0 809.1 4,490.1 3,071.1 398.5 $10,385.8 $10,256.4 $ $ 257.6 325.6 639.9 724.2 560.0 83.5 710.0 648.2 2,001.7 4,052.9 706.5 313.1 7,074.2 1.947.3 4,443.9 1,094.5 329.2 7,814.9

Solution for 6.

Based on the calculation the new WACC is 3.03%

As we are using WACC as a discounting rate we should change it to new rate of 3.03% from 7% as we get a better value by using as lower figure for discounting

For e.g. If we discount a project value of $ 100 at 3.03% we get for 1 year we get $ 97.06 and if we discount it with 7% we get $ 93.45, so I recommend revising the discounting rate from 7% to 3.03% to get better valuation for any project.