- Please respond to both of these questions with 250 words and include references.
- Discuss the best estimates of McCormick & Company’s capital structure used for the acquisition of new product lines. Give credit to any sources you use to support your statements.
McCormick and Company used Weighted Average Cost of Capital (WACC) to determine how much interest it will owe for each dollar it finances. WACC is the, “calculation of a firm’s cost capital in which each category of capital is proportionately weighted. All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation.” (Hargave, 2019).
Net Present Value (NPV) and Internal Rate of Return (IRR) are two other estimates that McCormick & Company can use to further assess the feasibility of the new product lines.
Discuss how understanding capital budgeting will impact the decision of McCormick and Company’s potential investment in a new factory. Give credit to any sources you use to support your statements.
According to Sarwary (2019), “it is crucial for enterprises to make an appropriate evaluation of their potential investments by using capital budgeting techniques (CBT). CBT are argued to be fundamental for effectively selecting potential investments because they enable capital to be allocated to productive investments”.
A company’s understanding of capital budgeting is crucial in assisting a firm in determining whether an investment opportunity will be positive. Will the investments generate profits or losses for the company? Capital budgeting answers this imperative question. McCormick & Company must consider their WACCand IRR for their potential investment in a new factory before officially undertaking the project. McCormick and Company’s WACC value was lower than the previous discount rate of 7% and they, therefore, should adjustment the current plan.
Hargrave, M (2019). Weighted Average Cost of Capital-WACC. Retrieved from https://www.investopedia.com/terms/w/wacc.asp
Sarwary, Z. (2019). Capital budgeting techniques in SMEs: A literature review. Journal of Accounting & Finance (2158-3625), 19(3), 97–114. Retrieved from http://search.ebscohost.com.ezproxy.umuc.edu/login…
- Best estimates of McCormick’s capital structure
McCormick and Company has a best estimated cost of equity of 8.763%. It can confidently invest at the international level since the cost of equity is higher than the cost off debt. According to Cao et al. (2017), a higher cost of equity means that a company does not require to pay. The higher cost of equity can be due to factors such as advantages of interest when making payments. Besides, using cost of equity to finance investing activities is more beneficial since it won’t be repaid. In short, the company is in a position to finance itself without relying on external debt. Additionally, McCormick and Company has a WACC of 7.589%. This is a relatively low rate which shows the company can continue with investing with minimal risks (Mari and Marra, 2019).
How understanding capital budgeting will impact McCormick and Company nesting decisions
Understanding the capital budgeting can impact the decisions McCormick and Company makes in regards to potential investments. The company already has a net present value $312.57 and an internal return rate of 18%. It can accept the investment project due to a higher IRR compared to the discount rate. However, other capital budgeting factors can influence the investment decisions. Almazan, Chen & Titman (2017) argues that a company should consider an analysis forecast before undertaking a capital budgeting decision. Additionally, it has to identify the competitive strategies of other business rivals by ensuring it has the same or better resources, i.e. machinery or equipment.
Almazan, A., Chen, Z., & Titman, S. (2017). Firm Investment and Stakeholder Choices: A Top‐Down Theory of Capital Budgeting. The Journal of Finance, 72(5), 2179-2228.
Cao, Y., Myers, L. A., Tsang, A., & Yang, Y. G. (2017). Management forecasts and the cost of equity capital: international evidence. Review of Accounting Studies, 22(2), 791-838.
Mari, C., & Marra, M. (2019). Valuing firm’s financial flexibility under default risk and bankruptcy costs: a WACC based approach. International Journal of Managerial Finance.
- Please revise the cost of capital tab questions 3 and 5.
Cost of Capital Tab
- Suggest creating a table with columns Bond Rate, Premium and Cost of Equity (and the table will have three rows). The first column has all 4% in the cells. The second column has the premiums which are 3%, 4%, and 5%. The last column has the sum of the first two. So the last column will show 7%, 8% and 9%.
- WACC = (.212)(.0290) + (.788)(.08)
The gap analysis need to expand the reflection part. For the summary, the sources need fixed–something happened with the printing (not readable).