Analyzing Financing and Investing Activities
To no small extent, healthy and productive investment decisions depend on efficient financial activities. Finance describes the position of money at the time it is wanted. It encompasses the strategic management of the flow of money in an organization. Therefore, finance represents a set of administrative functions in the firm that ensures the company has the means to effectively carry out its objectives as satisfactorily as possible (Kaddumi, 2016) . Since finance involves the rising, provision and management of all money, capital or funds of any kind that is used in the operations of any business, it is vital in investment activities. In the case of McCormick and Company, the decision to purchase a new factory in Largo, Maryland depends on what is paid for and when in addition to considering avenues to ensure the organization’s ability to raise money and subsequently earn income and profits in the best terms possible as associated with the new investment.
Since finance emphasizes the importance of devoting available funds to the best use possible the net present value analysis illustrates that it will be a good business move if McCormick and Company were to invest in a new factory in Maryland. Indeed, the purchase price of the factory is four million dollars, and McCormick and company believe that it can produce a net cash inflow of approximately 780,000 dollars each year for a decade, at the prevailing discount rate of 14 percent, should purchase the company at the asking price of four million dollars. In this instance, the decision to buy the factory at Largo, Maryland, is grounded on the premise that the net present value is positive. Net current value illustrates the present value of cash inflow less the present value of cash outflow. Discounting the 780,000 dollars that are expected in returns to the 14 percent prevailing discount rate, the current amount of cash inflow is 4, 068, 558, which exceeds the asking price of four million dollars. Therefore, it will be a well-informed investment decision for McCormick & Company to invest in a new factory in Largo, Maryland.
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A right investment decision goes beyond the analysis of the net present value that shows the financial position of an organization at present to illustrate the profit margins. An investment decision is considered successful if it adds value to the firm by being profitable to the shareholders (Kaddumi, 2016) . Therefore, the decision to invest in a new factory depends on the after-tax profit that McCormick & Company will enjoy the purchase of the factory. Taking the total sales which are currently estimated at 780,000 less the expenses, depreciation and the tax, the total profit after tax is at 243,000 an evident increase in McCormick & Company profit margins. Since the decision to invest in the factory in Maryland increases the profit margins, it will be a smart and profitable decision to purchase the factory.
Apart from the profitability of a potential investment, it is necessary to account for the risks and associated returns of a business venture. Given the present cash inflows adjusted for a 13 percent risk for each of the first five years associated with the decision to purchase the Maryland factory, it is necessary to find the discount rate at which each of the present value of cash flows has been calculated. At a discount rate of 20 percent, accounting for risk illustrates that it will not be smart for McCormick &Company to invest in the factory since the total present value of cash inflows is 737, 013 showing a negative net present value. Indeed, if the viability of the project is a mere half a decade, it is not advisable for McCormick & Company to invest in the factory.
Investment decisions extend beyond the acquisition of new production plants to encompass product line expansions. It is a known financial concept that given two alternatives, for instance, the option of two projects associated with product line expansion, it is smart to pick the option with the highest net present value adjusted risk (Kaddumi, 2016) . In the case of McCormick & Company where there are two options Project A which has lower future cash flows compared to B while project A is less risky since it is closely related to McCormick’s current endeavors, it is advisable to pursu e project A compared to B. This is because the net present value of project not only definite but also higher than that of project B. Therefore, in project line expansions, it is crucial for managers to take into account the initial investment, the annual cash flows in addition to the rate of risk in efforts of avoiding negative returns in future.
Determine Corporate Valuation
Financing and investing activities should work to create value in the organization. Therefore, in one paradigm, a financial manager who acts in the interest of the shareholders should ensure he or she invests in projects that increase the overall firm’s value, including the share value. On the other, it is vital for managers to be conversant with the necessary mix of financial resources and their applications and how they contribute positively to the organization. Valuation of the performance of an organization is grounded on different aspects including but not limited to dividends, yields, options, warrants, derivatives and discount rate which illustrate whether or not it is a viable option to invest in a particular business sector.
The decision on whether or not McCormick & Company should purchase the company in Maryland depends on how the investment will affect the intrinsic value of the company. Intrinsic value describes the value of a company, including the stock, currency or the product she is compiled through fundamental analysis without any reference to the market value. In efforts of financing the purchase of the Maryland factory, McCormick & Company is considering issuing additional common stock. According to the comprehensive data, the company recently paid a dividend of 0.52 dollars per share. Company projections indicate that the dividends are expected to grow by approximately 8.5% each year for the next half a decade. Therefore, in efforts of purchasing the factory in Maryland if the required return of the stock is twelve percent, then today's stock price of McCormick & Company is 15.04 dollars. This value is approached through considering the current dividend per share, the dividend growth rate per year, which gives the terminal amount of dividends that are discounted with the required rate of return. The intrinsic value is significant since it reflects on the value of a company without the influence of external factors and as such more valuable metric compared to the estimated market value.
Valuation of performance involves the analysis of the costs and the benefits associated with selling the stock of a company. For instance, if the current price of an American call option with exercise price is 80 dollars, but the amount written on McCormick & Company stock is 41.40 dollars. If the current rate of one McCormick & Company stock is 123.13, selling the stock illustrate accounting for the payoff which is given by current price less the exercise price. That is 123.13 less 80 dollars, which provide 43.13 dollars. The profit encompasses subtracting the call price from the payoff, which is given by 43.13 less 41.40, which is 1.73 dollars.
Given the risk premium of thirteen percent is associated with the investment in a new factory in Maryland in addition to the current risk-free rate of seven percent, the minimum acceptable rate of return is given by the addition of the risk premium and the risk-free rate which translates to twenty percent minimum acceptable rate of return (MARR). MARR often illustrates the minimum rate of return that a company is willing to accept before embarking on a project taking into account its risk and the opportunity cost of undertaking that particular project instead of others. Since calculating the MARR requires looking at different aspects of an investment opportunity, it is a useful technique in determining whether the investment is worth it.
As mentioned, expansion decisions extend beyond the physical acquisition of plants to encompass investments in new products. Similar to purchases, product line requires careful analysis of the cost of equity associated with the project to determine the right financing option and the importance of establishing an appropriate discount based on the weighted average cost of capital. In the event of McCormick & Company where the cash flows are assumed to be steady, the nominal risk-free rate for a short-term US government treasury bills is 1.5%, and the 10-year government bonds rate is 2.5% and the inflation rate is at 2.54% the risk free rate is given through taking the ratio of the nominal risk free rate and the inflation rate less one. In this particular rate, the real risk-free rate is zero. Therefore the cost of equity through the CAPM model is given by beta multiplied by the market return, which gives the cost of equity at six percent.
Risks and Returns
Return on an investment describes the profit that is expressed as a percentage of the initial capital inflow. The benefit extends beyond the gains to the shareholders to encompass income and capital gains. Risks, on the other hand, illustrate the possibility that the investment will not be successful (Senthilnathan, 2016) . In any investment decision, the risks and returns are highly coordinated.
In many cases, an increase in potential return is often associated with increased risk and vice versa. It is essential to acknowledge that each risk is related to different types of threats from project-specific threats, to industry-specific risks to competitive risk, to market risk to global risks, among others. Over the past half a century, the concept of diversification has gained momentum since it allows for the reduction of the overall risk associated with a particular portfolio (Senthilnathan, 2016) . However, in efforts of reducing risks, diversification my work to reduce the potential returns.
One core aspect in McCormick & Company endeavors to invest in a new factory in Maryland is the market risk premium which illustrates the additional return that an investor will enjoy in the efforts of holding a risky market portfolio. The market risk premium is often used to calculate the acceptable rate of return for an investment. In many cases, an investment, for instance, the decision to purchase a factory in Maryland will be successful and preferred when there is the highest possible rate of return combined with the lowest volatility of returns. For investment equity risks as it is the case with product line expansion in McCormick & Company, the risk is analyzed by looking at the variance of actual returns and the expected returns. In the Capital Asset Pricing Model (CAPM), the exposure to market risk is illustrated through the beta. Since the US treasury bills are not associated with any level of risk, they are often used to demonstrate the risk-free investments (Senthilnathan, 2016) . Therefore utilizing the CAPM multiplying the beta, this is the market risk, and the market return gives the cost of equity. The coordination between risks and returns often allows an investor, in this case, McCormick & Company to make informed decisions which facilitate an increase in sales and subsequently profit margins in addition to increasing the value of an organization. In-depth analysis of the market risk premium and the current market-free rate including the market risks among other aspects allow McCormick & Company to invest in a new factory in Maryland after a careful financial analysis on equity and financial resources rather than heavily relying on net present value.
Annuities
Annuities describe a series of payment that is made at equal payments and encompasses but not limited to regular deposits to a savings account, monthly mortgage payments, insurance payment and pensions, among others. The daily deposits to a saving account are intended to protect individuals from the risk of outliving their income since the payments are grounded on life expectancy. In the above case, Liz is turning seventy next year after 39 years of service in the US postal service. Her monthly pension is 7,500, but she has accumulated 700,000 dollars in her thrift saving plan. She has the option of either converting the amount to an annuity or move it to an IRA. The best part about moving it to an IRA is the fact that the money will not be taxed.
The annuity amount depends on her life expectancy of 17.5 years after the age of 70. If the current US Treasury long term bond rate is at three percent, Liz will earn an annuity amount of 4, 288.61 dollars per month. This amount is arrived at by considering the total amount in the thrift account is equal to the monthly annuity that is discounted over the twelve months in a year and the prevailing US treasury long term bond rate. From the analysis including regulatory requirements on withdrawal both for annuities and the IRA, Liz should take the annuity to avoid paying to have to wait until she is 70.5 years to be eligible to make withdrawals from the IRAs. The fact that she does not qualify for social security illustrates that an immediate withdrawal of funds will be beneficial to her. In addressing the concept of a tax associated with annuities, once the annuity balance falls below the amount that was initially paid as principal the withdrawals will no longer be taxed allowing Liz to enjoy one core advantage associated with IRAs. From the above case, it is evident that annuities are beneficial and profitable since they not only protect an individual from the risk of outliving their income but also can avoid the aspect of taxing when withdrawals are made up to the point of the initial principal amount.
Another type of annuity is mortgage payments, which encompasses regular payments scheduled that includes a portion of the principal and interest paid by the home loan borrower to the home provision account. In the case of Kathy who plans to move to Maryland to work with McCormick& Company and intends to buy a house at a budget of 500,000 dollars, Kathy and her husband should choose the 15 year plan at four percent although the payment will be significantly higher compared to the 30 year mortgage plan, Kathy and her husband will pay relatively low in terms of interest with the 15 year plan. Indeed, while the monthly payment of the 30-year mortgage plan is 3.026.74 dollars, besides, the 1,000 dollars for taxes and insurance the payment for the 15-year mortgage at four percent is 3,958.67 dollars the total amount in terms of interest in the 30-year plan is higher. Therefore, in choosing a mortgage plan, it is crucial to analyze beyond the payment period and the interest rate and compute the monthly payments and subsequently, the total amount of payment associated with a particular plan.
References
Kaddumi, T., (2016). Financial analysis and investment decision_ Empirical study on the Jordanian stock market 2011-2015. International Journal of EconomicResearch, 14 (18).
Senthilnathan, S., (2016). Risk, return and portfolio theory- A contextual note. International Journal of Science and research, 5 (10), 705-715.
