The report aims at providing analysis and assessment of long-term value implications of investing, acquisition as well as financing by McCormick & Company. The report will give a detailed explanation of the future value of the investment undertaken by the company in a new factory situated in Largo, Maryland. The report also provides an analysis of the return, expected on the issued stock and the cost of equity of McCormick & Company. It will also give a summary of the annuities, retirement options as well as mortgage rates being considered by Kathy, who is planning to be an employee of McCormick & Company.
Findings
Various methods of analysis are used to evaluate the long-term value implications of finance and investments of McCormick & Company. The need to keep up with the demand pushes the company to decide on constructing a new company in Largo, Maryland. However, the returns on investment on the new project remain uncertain, and the company requires an evaluation of risk and return. On the other hand, the landowner, James Francis, must decide which offer to take since both of them are competing. The competing company has provided a price of $3,000,000, and McCormick & Company had to raise the offer to $4,424,000 to outbid their competitor (Schoenmaker & Schramade, 2018). The future value of the two competing offers is identified to help James decide the best offer. The offers are multiplied by 12%, which is the interest rate offered by James’s bank to obtain the future value. McCormick & Company’s price has the highest amount of future value, and this makes it the best.
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For the company to finance the project and have minimal effects on the operating cash flows, a 70% loan is necesary (Hens & Hoppe, 2018). A down payment of 30% is required to secure the loan meant to buy land and develop the factory. Three categories of loan options are available for the company to decide which the best is. The first option has a 6% annual interest rate, and the loan is to be repaid in twenty years. The second option requires that the loan be paid in 10 years at an interest of 4.5% annually. The final option has a payback period of 15 years at an interest rate of 5%. The company uses the present value method to determine the best loan option that has a shorter repayment period to avoid future risks. Though the three loan options have various interest rates and payback periods, the present value is the same, which is $3,096,800. However, the first option has the lowest amount to be paid monthly, that is, $22,186.44.
The second option has the lowest total paid back the amount of $3,851,368.09 and also the highest monthly payment of $ 32094.74.The company also uses a 10-year treasury with a rate of 2.03% which is risk-free. The geared beta of the company is 0.60, and the market return expected is 8.03%. For the company to determine the return expected on stock issued, a model in capital budgeting is used. The following formula is used to calculate the return on the issued stock.
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Therefore the expected return is 2.03% +0.60 (8.03%-2.03%) = 5.63%
A dividend discount model is used to find out the return expected on the stock of McCormick & Company. The company’s dividend per share for the coming year is $2.28, with a fixed growth rate of 8.70%. The price per share of stock is $155.70. The cost of equity is calculated as follows.
Therefore, the cost of equity is 1.46% +8.70%= 10.16%
In the case of Liz, if she decides to go with the annuity, she will receive a monthly amount of $4,288.62, that is, before tax. Considering it is taxable, she will have to pay a 24% interest rate as per the IRS (Internal Revenue Authority) regulations. However, should Liz transfer the money to IRA (Individual Retirement Account), she could receive up to 2.5% interest according to the current IRA rates annually, which is tax exempted; that would earn her $1458 monthly. However, this choice has its disadvantages because she could incur penalties suppose she makes early withdraws. According to Evensky et al. (2016), IRA offers tax advantage, whether it is Roth IRA or Traditional IRA; the investment grows in the account tax-free. Traditional IRAs comprises of tax-deductible contributions, but taxable distributions. Whereas in Roth IRAs contributions are not tax-deductible, but the receivables are free from taxation. If Liz were to decide on the best kind of IRA, the ideal one would be Roth because she is not making any contributions.
With annuities, there is no levy for the initial investment; however, the earnings are taxed depending on the current income tax-rate (Dorman et al., 2016). The major setback would be in the hidden expenses such as surrender charges, commissions, and high annual rates. From this information, it is possible to find out the best option for Liz. Regarding Stan and Kathy, if they decide to take the 15-year mortgage plan, they will have to pay $2958.75 plus $1000 totaling $3958.75 monthly payment. On the other hand, if they take the 30-year plan, she will pay a total of $3026.74. Overall, the 30-year plan will have an excess of 197,051.54 in payments. However, the 15-year plan is dependent on their ability to pool a higher amount each month.
Conclusion and Recommendations
The report concludes that the company will be able to keep up with the market demands since it will be able to fund the building of the new factory in Largo, Maryland. The recommendations discussed include choosing the loan option with the highest amount of monthly payments and the lowest total paid back amount. The company should select option two, which have a shorter period to minimize the future risks of inflation. In the case of Liz, the best choice would be to deposit her money to the Roth IRA. That way, she will earn $1488 monthly interest, which is tax-exempted, unlike the annuities where she will receive more monthly annuity but taxable.
Furthermore, she will keep her principle amount depending on the agreement with the IRA. However, if the interest is not enough to cater to her monthly expenses, the ideal option would be an annuity. For Stan and Kathy, they should take the 15-year mortgage; this is because they will save on the total amount paid. However, it depends on their ability to contribute $932.01 more every month. According to Amromin et al. (2018), short term mortgages are ideal as they reduce the total amount of interest paid.
References
Amromin, G., Huang, J., Sialm, C., & Zhong, E. (2018). Complex mortgages*. Review Of Finance , 22 (6), 1975-2007. https://doi.org/10.1093/rof/rfy016
Dorman, T., Mulholland, B., Bi, Q., & Evensky, H. (2016). The efficacy of publically-available retirement planning tools. SSRN Electronic Journal . https://doi.org/10.2139/ssrn.2732927
Hens, T., & Schenk-Hoppé, K. (2018). Patience is a virtue: In value, investing. International Review Of Finance . https://doi.org/10.1111/irfi.12251
Schoenmaker, D., & Schramade, W. (2018). Investing for long-term value creation. SSRN Electronic Journal . https://doi.org/10.2139/ssrn.3248912
