Returns
A return, also known as a financial return is the money made or lost on an investment. A return can be expressed nominally as the change in dollar value of an investment over time or as a percentage derived from the ratio of profit to investment. We will cover those ratios below. If we make a profit on our investment or venture, we have a positive return. If we lose money on our investment or venture, we have negative return.
A nominal return is the net profit or loss of an investment expressed in nominal terms (i.e., levels). It can be calculated by figuring the change in value of the investment over a stated time period plus any distributions minus any outlays. Distributions received by an investor depend on the type of investment or venture but may include dividends, interest, rents, rights, benefits, or other cash flows received by an investor. Outlays paid by an investor depend on the type of investment or venture but may include taxes, costs, fees, or expenditures paid by an investor to acquire, maintain, and sell an investment. For example, assume an investor buys $2,000 worth of publicly traded stock, receives no distributions, pays no outlays, and sells the stock two years later for $2,200. The nominal return in dollars is $2,200 - $2,000 = $200.
A percentage return is a return expressed as a percentage. It is known as the return on investment (ROI). ROI is the return per dollar invested and is calculated by dividing the dollar return by the dollar initial investment. This ratio is multiplied by 100 to get a percentage. Assuming a $200 return on a $1,000 investment, the percentage return or ROI = ($200 / $1,000) × 100 = 20 percent.
A holding period return is an investment's return over the time it is owned by a particular investor. Holding period return may be expressed nominally or as a percentage.
Rate of return is the proportion of profit earned from an investment during a periodic interval of time, expressed as a percentage. For example, the return earned during the periodic interval of a month is a monthly return and of a return earned during a year is an annual return.
Returns over periodic internals of different lengths can only be compared when they have been converted to same length intervals. It is customary to compare returns earned during yearlong intervals. Return of capital refers to the recovery of the original investment.
Return Ratios
Companies use different kinds of return ratios to compare one investment option to another one:
· Return on equity (ROE) is a profitability ratio figured as net income divided by average shareholder's equity, which measures how much net income is generated per dollar of stock investment. If a company makes $10,000 in net income for the year and the average equity capital of the company over the same time period is $100,000, the ROE is 10 percent.
· Return on assets (ROA) is a profitability ratio figured as net income divided by average total assets, which measures how much net p.
ReturnsA return, also known as a financial return is the money m.docx
1. Returns
A return, also known as a financial return is the money made or
lost on an investment. A return can be expressed nominally as
the change in dollar value of an investment over time or as a
percentage derived from the ratio of profit to investment. We
will cover those ratios below. If we make a profit on our
investment or venture, we have a positive return. If we lose
money on our investment or venture, we have negative return.
A nominal return is the net profit or loss of an investment
expressed in nominal terms (i.e., levels). It can be calculated by
figuring the change in value of the investment over a stated time
period plus any distributions minus any outlays. Distributions
received by an investor depend on the type of investment or
venture but may include dividends, interest, rents, rights,
benefits, or other cash flows received by an investor. Outlays
paid by an investor depend on the type of investment or venture
but may include taxes, costs, fees, or expenditures paid by an
investor to acquire, maintain, and sell an investment. For
example, assume an investor buys $2,000 worth of publicly
traded stock, receives no distributions, pays no outlays, and
sells the stock two years later for $2,200. The nominal return in
dollars is $2,200 - $2,000 = $200.
A percentage return is a return expressed as a percentage. It is
known as the return on investment (ROI). ROI is the return per
dollar invested and is calculated by dividing the dollar return by
the dollar initial investment. This ratio is multiplied by 100 to
get a percentage. Assuming a $200 return on a $1,000
investment, the percentage return or ROI = ($200 / $1,000) ×
100 = 20 percent.
A holding period return is an investment's return over the time
it is owned by a particular investor. Holding period return may
be expressed nominally or as a percentage.
Rate of return is the proportion of profit earned from an
investment during a periodic interval of time, expressed as a
2. percentage. For example, the return earned during the periodic
interval of a month is a monthly return and of a return earned
during a year is an annual return.
Returns over periodic internals of different lengths can only be
compared when they have been converted to same length
intervals. It is customary to compare returns earned during
yearlong intervals. Return of capital refers to the recovery of
the original investment.
Return Ratios
Companies use different kinds of return ratios to compare one
investment option to another one:
· Return on equity (ROE) is a profitability ratio figured as net
income divided by average shareholder's equity, which measures
how much net income is generated per dollar of stock
investment. If a company makes $10,000 in net income for the
year and the average equity capital of the company over the
same time period is $100,000, the ROE is 10 percent.
· Return on assets (ROA) is a profitability ratio figured as net
income divided by average total assets, which measures how
much net profit is generated for each dollar invested in assets. It
determines financial leverage and whether enough is earned
from asset use to cover the cost of capital. Net income divided
by average total assets equals ROA. For example, if net income
for the year is $10,000, and total average assets for the company
over the same time period is equal to $100,000, the ROA is
$10,000 divided by $100,000, or 10 percent.
Evaluating Investment Options
The first category of your investment plan is risk and return
objectives. This category describes your expectations for
returns on your investments. These expectations will, to a large
extent, determine your asset allocation decisions. In other
words, these expectations will determine how you will
distribute your investments among different asset classes. This
category also addresses your expectations for risk and outlines
how much risk you are willing to accept.
Expected Returns
3. You should not invest without specific goals in mind. For your
first goal, you should decide what return you expect your total
portfolio to make over a specific time period. You cannot know
with certainty what the actual returns will be before you invest.
However, you can estimate an expected return, or a goal that
you hope to achieve during a certain period of time (such as a
week, a month, or a year). Be aware that your expected return
will have a major impact on what your portfolio looks like:
· An expected annual return of 2 to 3 percent will likely be the
result of a well-diversified, very low-risk portfolio.
· An expected annual return of 4 to 6 percent will likely be the
result of a well-diversified, low-risk portfolio.
· An expected annual return of 7 to 8 percent will likely be the
result of a well-diversified, moderate-risk portfolio.
· An expected annual return of 9 to 10 percent will likely be the
result of a less-diversified, high-risk portfolio.
· An expected annual return that is greater than 10 percent will
likely be the result of an undiversified, very high-risk portfolio
that is heavily dependent on high-risk assets.
Note that you will determine your expected returns for two
periods of time: before retirement and during retirement.
There are several ways to estimate your expected returns. To
give you an idea of how to estimate your expected returns over
a period of time longer than one year, it may be helpful to look
at the long-term history of the asset classes you have selected.
Expected Risk
Since a higher expected return requires you to accept more risk,
it is important that you know your risk-tolerance level, or your
willingness to accept risk. Your age and feeling of financial
security will likely have a big impact on how much risk you are
willing to take. In general, when people are younger they are
more willing to accept risk because their investments will have
more time to grow and overcome loses. As people grow older,
they usually become less willing to accept risk because they
will need their investment funds sooner for retirement and other
purposes. Investors that have a low tolerance for risk should
4. typically devote the majority of their portfolios to bonds and
cash because these investments are the least risky of all asset
classes; however, these investments also have the lowest
returns. Investors that are willing to accept more risk may
allocate more of their portfolio to US and international stocks,
versus investments in bonds and cash. The challenge of wise
investing is to balance your risk and return expectations with
your situation in life and your personal goals.
Defining risk in your portfolio is a challenge. Professional
investors usually state an annual standard deviation as the
acceptable risk level for their portfolio—for example, 12
percent. From a financial standpoint, this means that 66 percent
of the time the investor’s risk will be within one standard
deviation (plus or minus 12 percent) of their mean or average
return. If an investor’s average return is 8 percent, this means
that there is a 66 percent chance that the investor’s returns will
be between -4 percent (8 percent - 12 percent) and 20 percent (8
percent + 12 percent). While using a standard deviation to
define risk may be helpful for some, this method will not work
for everyone. I would like to propose a simpler way of defining
risk: using investment benchmarks.
Instead of defining your risk tolerance level in terms of a
standard deviation, you can simply define your risk tolerance
level by deciding that you are willing to accept the risk of the
benchmarks you have chosen for your portfolio. You can
determine how risky a particular asset is by looking at
your investment benchmark. If you have a small-capitalization
stock mutual fund or asset that has had a return of 7.5 percent
over the last ten years and a standard deviation of 25.3 percent,
you can compare this asset to an investment benchmark for
small-capitalization stocks.
You can also determine a portfolio’s risk level by comparing
the portfolio to weighted individual benchmarks. For example,
if you choose a portfolio that is made up of 50 percent US
stocks, 20 percent international stocks, 25 percent bonds, and 5
percent real estate (all percentages should add up to 100
5. percent), then your risk is equal to the risk defined by the
benchmarks of each of these asset classes. In this case, your risk
would be equal to the benchmarks of each element in a portfolio
that contains 50 percent US stocks (as measured by Standard
and Poor’s 500 Index, a major benchmark for large-
capitalization stocks); 20 percent international stocks (as
measured by MSCI Europe Australia, Far East Index, or EAFE,
a major benchmark for international stocks); 25 percent bonds
(as measured by the Lehman Aggregate Index, a major
benchmark for bonds); and 5 percent real estate (as measured by
Standard and Poor’s REIT Index, a major benchmark for real
estate investment trusts).
Risk
The term financial risk is broad, but can be broken into
categories to understand it better:
· Asset-backed risk affects investments in asset-backed
securities, such as home loans. In order to finance home sales,
banks issue bonds that serve as a debt obligation to its buyer.
The buyer of the debt is essentially receiving the interest from
the bank that the home-buyer is paying to it.
· Prepayment risk is the risk that the buyer goes ahead and pays
off the mortgage. Therefore, the buyer of the bond loses the
right to the buyer’s interest payments over time.
· Interest rate risk refers to an asset whose terms can change
over time, such as a variable rate mortgage payment.
· Credit risk or default risk, is the risk that a borrower will
default (or stop making payments).
· Liquidity risk is the risk that an asset or security cannot be
converted into cash in a timely manner. Some investments (i.e.,
stocks) can be sold immediately at the current market rate and
others (i.e., houses) are subject to a much higher degree of
liquidity risk.
· Market risk is the term associated with the risk of losing value
in an investment will lose value because of a decline in the
6. market.
· Operational risk is another type of risk that deals with the
operations of a particular business. If you are invested in the
Boston Red Sox, your operational risk might include the chance
that starting pitchers and recently acquired players won’t
perform, that your manager will turn the clubhouse into a mess,
or that ownership will not be able to execute a long term
strategy. Any of these risks might result in decreased revenues
from ticket sales.
· Foreign investment risk involves the risk associated with
investments in foreign markets.
· Model risk involves the chances that past models, which have
been used to diversify away risk, will not accurately predict
future models.
A recent phenomenon that applies the concepts of these risks
and how they interact with each other happened in 2008 when
the housing market crashed. Can you find an example of each
form of risk here?
Leading up to the crisis, many people received loans to buy
houses which they really couldn’t afford. The mortgages often
featured variable rate annuities, meaning that the interest rate
terms of the mortgage started low and increased over time. Over
the prior 20 years, house prices had risen constantly, and
investors assumed the trend would continue. Buyers worried
about an adjustment to their interest rate, and all of a sudden a
1,500 monthly payment became 2,000. When interest rates
climbed two percentage points and the mortgage climbed to
$2,000, some owners had to default (stop making payments).
They were promised that their investment would appreciate in
value and they would be able to refinance it. The home loans
were packaged and shipped off to investors all over the world in
the form of complex investment vehicles. They seemed
rewarding and highly safe at first, but then a few started
breaking down. By now, these vehicles had made their way all
the way around the world. When some investors defaulted, the
world realized there were no mechanics around to fix these
7. vehicles. After a few vehicles broke down, no one wanted to
buy them, leading to the worst crash across world markets since
1929.
Measuring Risk
The higher the risk undertaken, the more ample the expected
return and the lower the risk, the more modest the expected
return.
Risk refers to the variability of possible returns associated with
a given investment. Risk, along with the return, is a major
consideration in capital budgeting decisions. The firm must
compare the expected return from a given investment with the
risk associated with it. Higher levels of return are required to
compensate for increased levels of risk. In other words, the
higher the risk undertaken, the more ample the return; and
conversely, the lower the risk, the more modest the return.
This risk and return tradeoff is also known as the risk-return
spectrum. There are various classes of possible investments,
each with their own positions on the overall risk-return
spectrum. The general progression is short-term debt, long-term
debt, property, high-yield debt, and equity. The existence of
risk causes the need to incur a number of expenses. For
example, the more risky the investment the more time and effort
is usually required to obtain information about it and monitor
its progress. Moreover, the importance of a loss of x amount of
value can be greater than the importance of a gain of x amount
of value, so a riskier investment will attract a higher risk
premium even if the forecast return is the same as upon a less
risky investment. Risk is therefore something that must be
compensated for, and the more risk the more compensation is
required.
When a firm makes a capital budgeting decision, they will wish,
as a bare minimum, to recover enough to pay the increased cost
of investment due to inflation. Thus, inflation is a pivotal input
in a firm’s cost of capital. However, since interest rates are set
by the market, it happens frequently that they are insufficient to
compensate for inflation.
8. Inflation
Inflation is a rise in the general level of prices of goods and
services in an economy over a period of time.
Risk aversion also plays an important role in determining a
firm’s required return on an investment. Risk aversion is a
concept based on the behavior of firms and investors while
exposed to uncertainty to attempt to reduce that uncertainty.
Risk aversion is the reluctance to accept a bargain with an
uncertain payoff rather than another bargain with a more
certain, but possibly lower, expected payoff. For example, a
risk-averse investor might choose to put his or her money into a
bank account with a low but guaranteed interest rate, rather than
into a stock that may have high expected returns, but also
involves a chance of losing value. Risk aversion can be thought
of as having three levels:
1. risk-averse or risk-avoiding
2. risk-neutral
3. risk-loving or risk-seeking
Beta is a measure firms can use in order to determine an
investment’s return sensitivity in relation to overall market risk.
Beta describes the correlated volatility of an asset in relation to
the volatility of the benchmark that said asset is being compared
to. This benchmark is generally the overall financial market and
is often estimated via the use of representative indices, such as
the S&P 500. Beta is also referred to as financial elasticity or
correlated relative volatility, and can be referred to as a
measure of the sensitivity of the asset’s returns to market
returns, its nondiversifiable risk, its systematic risk, or market
risk. Higher-beta investments tend to be more volatile and
therefore riskier, but provide the potential for higher returns.
Lower-beta investments pose less risk, but generally offer lower
returns.
Traditionally, a firm’s risk management function ensured that
the pure risks of losses were managed appropriately. The risk
manager was charged with the responsibility for specific risks
9. only. Most activities involved providing adequate insurance and
implementing loss-control techniques so that the firm’s
employees and property remained safe. Thus, risk managers
sought to reduce the firm’s costs of pure risks and to initiate
safety and disaster management.
Typically, the traditional risk management position has reported
to the corporate treasurer. Handling risks by self-
insuring (retaining risks within the firm) and paying claims in-
house requires additional personnel within the risk management
function. In a small company or sole proprietorship, the owner
usually performs the risk management function, establishing
policy and making decisions. In fact, each of us manage our
own risks, whether we have studied risk management or not.
Every time we lock our house or car, check the wiring system
for problems, or pay an insurance premium, we are performing
the same functions as a risk manager. Risk managers use agents
or brokers to make smart insurance and risk management
decisions.
The traditional risk manager’s role has evolved, and
corporations have begun to embrace enterprise risk management
in which all risks are part of the process: pure, opportunity, and
speculative risks. With this evolution, firms created the new
post of chief risk officer (CRO). The role of CROs expanded the
traditional role by integrating the firm’s silos, or separate risks,
into a holistic framework. Risks cannot be segregated—they
interact and affect one another.
In addition to insurance and loss control, risk managers or
CROs use specialized tools to keep cash flow in-house. Captives
are separate insurance entities under the corporate structure—
mostly for the exclusive use of the firm itself. CROs oversee the
increasing reliance on capital market instruments to hedge risk.
They also address the entire risk map—a visual tool used to
consider alternatives of the risk management tool set—in the
realm of nonpure risks. For example, a cereal manufacturer,
dependent upon a steady supply of grain used in production,
may decide to enter into fixed-price long-term contractual
10. arrangements with its suppliers to avoid the risk of price
fluctuations. The CRO or the financial risk managers take
responsibility for these trades.
They also create the risk management guideline for the firm that
usually includes the following:
· writing a mission statement for risk management in the
organization
· communicating with every section of the business to promote
safe behavior
· identifying risk management policy and processes
· pinpointing all risk exposures (what “keeps employees awake
at night”)
· assessing risk management and financing alternatives as well
as external conditions in the insurance markets
· allocating costs
· negotiating insurance terms
· adjusting claims adjustment in self-insuring firms
· keeping accurate records
· writing risk management manuals set up the process of
identification, monitoring, assessment, evaluation, and
adjustments.
In larger organizations, the risk manager or CRO has differing
authority depending upon the policy that top management has
adopted. Policy statements generally outline the dimensions of
such authority. Risk managers may be authorized to make
decisions in routine matters but restricted to making only
recommendations in others. For example, the risk manager may
recommend that the costs of employee injuries be retained
rather than insured, but a final decision of such magnitude
would be made by top management.
Instructions
Instructions
11. To complete this workbook, answer the questions on each
worksheet in the space provided.
Financing and Investing
Questions
1. McCormick & Company is considering purchasing a new
factory in Largo, Maryland. The purchase price of the factory is
$4,000,000. McCormick & Company believes they can produce
a net cash inflow of $780,000 a year for 10 years. If the
discount rate is 14 percent, should McCormick & Company
purchase the factory at the $4,000,000 asking price?
2. If McCormick & Company decides to purchase the new
factory in Largo, they need to consider relevent after-tax cash
flow. McCormick & Company estimated their potential first-
year sales revenue at $780,000, expenses at $225,000, and
depreciation expense at $150,000. McCormick's marginal tax
rate is 40 percent (21 percent federal and 19 percent state
combined). What is first-year relative cash flow?
3. The estimated relevent annual expected cash flows (C1)
associated with the puchase of the new factory in Largo are as
follows:
YearC1PV(C1)
1??
2$291,000$202,083
3$191,000$110,532
4$306,000$147,569
5$424,000$170,396
In Year 3, the estimated relevent annual expected cash flows
represents funds used to pay operating expenses for subsequent
years. All estimated relevent annual expected cash flows
include a risk premium of 13 percent, which has already been
applied to the cash flows above. Solve for cash flow for Year 1
12. based on your answer in Question 2. Then, solve for present
value (PV) for Year 1. What is the total of present value for all
five years? Should the factory be purchased? Why or why not?
4. McCormick & Company is also considering introducing two
new product lines to be made at the new factory (if it is
purchased). As a new member of MCS's finance team, you are
asked to determine whether McCormick & Company should
invest in the two product line expansions. Project A has lower
future cash flows than Project B, but because Project A is more
closely related to McCormick's existing product line, the
company feels it is less risky than Project B. You’ve done some
more analysis and have formulated the following future profits
for each project (with the first cash flow occurring one year
from now). Each project is expected to have a life of 5 years.
Year 1 Year 2 Year 3 Year 4 Year 5
Project A $5M $10M $10M $15M$15M
Project B $5M $10M $15M$20M $20M
You also believe that each project will require about $40
million in upfront investment. Finally, based on the different
risk assumptions, you believe that Project A should use a
discount rate of 7 percent, while Project B will have a discount
rate of 20 percent. Which project or projects should the
company undertake?
Answer Questions 1 to 4 here. Show your calculations.
Valuation of PerformanceShow your answers below:
Questions
1. McCormick & Company is considering buying a new factory
in Largo, Maryland. The company is considering issuing
additional common stock to finance the purchase of the factory.
McCormick & Company stock has recently paid a dividend
13. payment of $0.52 per share. Dividends are expected to grow by
8.5 percent per year for the next five years. The required return
on the stock is 12 percent. Determine the intrinsic value of the
stock, also known as today's stock price.
2. The current price of an American call option with exercise
price $80, written on McCormick & Company stock is $41.40.
The current price of one McCormick & Company stock is
$123.13. If you were to sell the stock, how much money would
you expect to make?
3. McCormick & Company is considering establishing new
products in a new factory in Largo, Maryland. The project is
expected to last for eight years. To determine the right
financing option, you need to determine the appropriate
discount based on the weighted average cost of capital. The cost
of equity is estimated using the capital asset pricing model.
Cash flows are assumed to be steady, the nominal risk-free rate
for the short-term US government treasury bills is 1.5 percent,
the 10-year government bonds rate is 2.5 percent, and the
inflation rate is 2.54 percent. What is the real risk-free rate?
Then, assume a beta of 1.2 and a market return of 5 percent.
What is the cost of equity?
4. McCormick & Company is considering purchasing a new
factory in Largo, Maryland. After you and your team have
conducted an analysis of alternative investments and cost of
capital, McCormick has decided that a risk premium of 13
percent is appropriate for the investment into a new factory.
Adding the risk premium to the current risk-free rate of 7
percent, what is the minimum acceptable rate of return?
Answer Questions 1 to 4 here. Show your calculations.
Annuities
Answer Questions 1 and 2 here. Show your calculations.
Questions
14. 1. Liz is retiring from the US Postal Service and will turn 70
next year. After 39 years of service, her monthly pension is
$7,500. She does not qualify for Social Security. Liz has
accumulated $700,000 in her thrift savings plan. The
government requires that she convert it to an annuity or move it
to a IRA. All of the money is pretax and tax can be avoided if
it is moved to the IRA. The annuity will be calculated based on
her life expectancy of 17.5 years after age 70. The current US
Treasury long-term bond rate is 3 percent. How much will she
get as an annuity monthly payment? Should Liz take the
annuity or move the money to the IRA? The tax regulations
require that she take out 4 percent of the amount each year.
2. Kathy plans to move to Maryland and take a job at
McCormick as the assistant director of HR. She and her
husband, Stan, plan to buy a house in Garrison, MD, and their
budget is $500,000. They have $100,000 for the down payment
and McCormick will pay for closing costs. They are
considering either a 30-year mortgage at 4.5 percent annual rate
or a 15 year mortgage at 4 percent. Calculate the monthly
payment for each. Property taxes and insurance will add $1,000
per month to which ever mortgage they choose. What should
Kathy and Stan do?
Start Here
Error! Filename not specified.
As a senior analyst at Maryland Creative
Solution
15. s (MCS), you have continued to prove your value after helping
Choice Hotels make strategic decisions by analyzing their
financial reports. Frank Marinara and Elisa Izuki, continually
happy with your work, have decided to transfer you to the
finance team. You’re excited to continue working for MCS and
you strongly believe you are capable of someday making senior
partner.
Dialogue with Frank Marinara
You meet with Frank so he can orient you to your new team.
“The finance team has a slightly different focus than the
accounting team,” he says. “The finance team is more involved
with analyzing financing and investment decisions, making
corporate asset valuations, evaluating corporate financial
performance, and providing corporate valuations. You will be
working to complete a project for our Maryland-based client
McCormick & Company.”
Given your position as a senior analyst, you are anticipating
that Frank will have several separate requests for your group.
Frank explains that McCormick & Company is considering
expanding their operations by purchasing another factory to
increase production of their spice products. The client has asked
MCS to help them determine if this financial investment is
worthwhile.
Frank continues by delineating your responsibilities for the
project: “To get started, we will need to look at the variables
16. involved in this purchase and the questions McCormick &
Company has provided. Ultimately, MCS will help them
determine their corporate valuation, responsibly raise capital,
and make the right financing and investing decisions. This
information will help you determine which financing and
investing options would provide McCormick & Company with
the best potential outcomes for sustainability and growth.
“You will also need to host a meeting with the other finance
analysts to discuss risk and returns,” Frank says. This
discussion will help the client decide if they should invest in
the new factory.
“The client also mentioned they would like MCS to provide
them with guidance on retirement plan options and other
employee benefits,” Frank elaborates. “Finally, I will need you
to complete the project by filing a report that highlights your
recommendations.”
Frank needs all of these assignments done within two weeks and
suggests you begin right away. Click Step 1 to get started!
When you submit your project, your work will be evaluated
using the competencies listed below. You can use the list below
to self-check your work before submission.
· 1.3: Provide sufficient, correctly cited support that
substantiates the writer’s ideas.
· 1.6: Follow conventions of Standard Written English.
17. · 3.1: Identify numerical or mathematical information that is
relevant in a problem or situation.
· 3.2: Employ mathematical or statistical operations and data
analysis techniques to arrive at a correct or optimal solution.
· 3.3: Analyze mathematical or statistical information, or the
results of quantitative inquiry and manipulation of data.
· 3.4: Employ software applications and analytic tools to
analyze, visualize, and present data to inform decision-making.
· 8.1: Evaluate major business/organizational systems and
processes and make recommendations for improvement.
· 10.3: Determine optimal financial decisions in pursuit of an
organization's goals.
· 10.4: Make strategic managerial decisions for obtaining
capital required for achieving organizational goals.
· 12.1: Assess market risk and opportunity.
Step 1: Analyze Financing and Investing ActivitiesINBOX (1
NEW EMAIL)
From: Frank Marinara, Director of Finance
To: You and Finance Team
I hope you have had a chance to get to know the team and are
ready to move forward with the project at hand. I want to give
you the background on the McCormick & Company case and
instructions for this project.
McCormick & Company approached MCS because they would
like to increase the production of their products and are
18. considering purchasing a new factory in Largo, Maryland. This
new factory would allow the company to increase its overall
production capacity. As McCormick decides whether to
purchase the new factory, they are asking our finance team to
evaluate options to finance this purchase. McCormick has
provided MCS with the purchase price, expected cash flow, and
two new product line projects they expect to run in the new
factory.
To understand which financing option would be best for the
client, you must first understand time value of money, present
value, future value, and loan amortization. These topics will
help your group make recommendations about the relative
benefits and drawbacks of each option.
Working in the attached Excel Workbook, complete the
Financing and Investing worksheet. The Financing and
Investing worksheet contains information about present value,
revenue, expenses, and cash flows, as well as questions that will
help Frank guide the client in selecting the best financing
option.
When you have completed the Financing and Investing
worksheet, submit it to the submission folder located in the
final step of this project. You should aim to complete this step
during Week 8. Then, proceed to Step 3, where you will
examine the factors affecting McCormick’s corporate valuation.
Looking forward to seeing your work,
19. Frank
ATTACHMENTS
McCormick & Company Workbook.xlsx
Step 2: Determine Corporate Valuation
McCormick & Company is also interested in gaining further
insight on the corporate valuation of the company, as they need
to know how much capital they’ll need to raise to purchase a
new factory. To understand valuation, you must
review dividends, options, warrants, derivatives, discount rate,
and yield.Dialogue with Frank Marinara
Frank tasks you with recommending a method for raising
sufficient capital. “McCormick & Company has been paying
dividends to its shareholders for several years now,” he says.
“The company has given us some data and would like us to
recommend ways they can further leverage their financing
activities. The company is interested in potentially issuing more
stock or purchasing bonds to raise additional capital for the
purchase of the new factory. I will need you to answer a few
questions about the company’s stock prices and minimum
acceptable rate of return. Your answers will help me make a
recommendation to McCormick.”
Working with the same Project 4 Excel Workbook you worked
with in Step 2, complete the Valuation of Performance
20. worksheet. This worksheet contains information on
McCormick’s dividends, stocks, and risk premiums, as well as
questions that will guide the client’s decisions.
When you have completed the Valuation of Performance
worksheet, submit the Project 4 Excel Workbook to the folder
located in the final step of this project. As you enter Week 9,
proceed to Step 4, in which you will discuss risk and returns
with your colleagues.
Step 3: Discuss Risk and Returns
Dialogue with Frank Marinara
As McCormick decides whether they will invest in an additional
factory to keep up with demand, the company remains uncertain
if the investment will yield worthwhile returns. “That is where
they need us to provide them with a risk and return evaluation,”
Frank says. “Risk is the financial liability a company takes in a
given investment in consideration of a potential return on the
investment.”
Meet and Discuss
Frank has asked you to meet with your colleagues and discuss
how risk and returns will influence McCormick’s investment
decision. Complete the following tasks:
· Discuss whether McCormick & Company should invest in a
new factory in Largo, Maryland. Give credit to any sources you
21. use to support your statements.
· Discuss how understanding risk and returns will impact this
decision. Give credit to any sources you use to support your
statements.
· Later in the week, after you are back in your office, you have
a follow-up discussion with your MCS colleagues in an effort to
summarize the key lessons from your discussion on risk and
returns at the meeting. Respond to your colleagues' original
discussion posts and give credit to any sources you use to
support your statements.
During Week 9, submit one original posting of at least 250
words in the Risk and Returns Discussion by Saturday and post
two responses of at least 50 words each to other discussion
participants by Tuesday. See MBA discussion guidelines.
This discussion will take place during Week 9 of the course.
When you have finished Step 4, proceed to Step 5, where you
will advise the client on selecting a retirement plan for its
employees.