Question

1. The company uses Goldman Sachs for its investment banker and Peter Fields, a Goldman Sachs...

1. The company uses Goldman Sachs for its investment banker and Peter Fields, a Goldman Sachs managing director, has suggested that McCormick consider on of two choices for financing. There is an innovative hedge fund group that will loan $350 million to Mc Cormick for 10 years in a zero interest bond. At the end, McCormick will owe $550 million. The fee to Goldman will be paid by the hedge fund.   Use the PV function to calculate the present value of the $350 million zero interest bond using a rate of 4%. Divide the rate by 2 and use 20 periods to compare to the standard bond. Make the $550 a positive number to see the cost today as a negative number. Compare to the $350 million that the company will get in cash if it agrees to this deal. Your answer should be a cost or negative number.

2. The alternative is a traditional 20 year bond that will pay 4% interest with semi annual interest payments of 2% of the amount owed. The principal ($350 million) will be due at the end of 20 years. The bond will be sold to mutual funds and life insurance companies. If Mc Cormick takes this alternative, it will owe Goldman Sachs a fee of 9/10 of 1% of the $350 million. This fee will be deducted from the initial proceeds of the bond sale. McCormick CFO would like to know which financing will cost less. To evaluate financing, Mc Cormick uses the current cost of debt which is 4% as the annual discount rate. Use the PV function. Make the $350 principal payment in year 20 a positive number to show it as a cost today. Calculate the Goldman fee as a cost today (time zero). Negative numbers are costs today. Use 4% divided by 2 (2%) as the semi annual discount rate. Use 40 periods.

3. Next we will calculate the effective interest rate for each alternative using the RATE function in Excel.    For the 20 year loan, we will use semi-annual compounding as interest is paid every 6 months. Enter 2% of the principal (minus 2% x $350) into the PMT box. Since there are 40 interest payments, enter 40 in the NPER box. Put the value at maturity as minus $350 into the FV box. Put the amount of cash that McCormick receives after paying the Goldman Sachs fee into the PV box ($350 minus the fee). Hit enter and find a semi annual fee slightly above 2% Show 2 decimal places. Multiply by 2 to go back to an annual rate. What is your answer in % for the annual rate?

4. Next use the RATE function for the zero Interest Loan. Since it is a 10 lyear oan and we want to make it comparable, we will set NPER equal to 20. We enter minus $550 in the FV box and $350 in the PV box. The functions will calculate a semi annual rate. Multiply by 2 to get the annual rate. What is your answer in % for the annual rate?

5, Now that you have two calculations for each loan, which is less cost? Which would you recommend and why?

6. We learned that one way to measure the financial risk is to calculate the Times Interest Earned ratio. We define it as EBIT / Interest Expense. For this question, we will ignore non operating Income. For Exxon Mobil, Choice Hotels, Marriott, and McCormick and Company, what is the times interest earned for 2017? For ease, there is a table below with the EBIT and Interest Expense for each company. I excluded the one time unusual gain of $668 million* for Marriott.

7. Times interest earned should be above 4.5 . If McCormick adds $14 million per year to its interest expense, and nothing else changes from the 2017 numbers, What will be the new Times Interest Earned?

8. If McCormick adds the year 1 net income and the year 1 tax amount that were calculated in the Q-2 table on the investing tab to EBIT, what will be forecast the Times Interest Earned?

Homework Answers

Answer #1

1)

A B C D E F G H I J K
2
3 Required rate of return 4%
4 Period 10 Years
5
6 Semi-annual rate (r) 2% =D3/2
7 Semi-annual Period (n) 20 =D4*2
8
9 Loan Amount borrowed $350 million
10 FV of Loan $550 million
11
12 RATE 2.00% =D6
13 NPER 20 =D7
14 PMT $0.00
15 FV $550
16 Present value of loan ($370.13) =PV(D12,D13,D14,D15)
17
18 Hence present value of loan is ($370.13)
19
20 Thus the actual cash received should be 370.13 million whereas the amount received is $350 million.
21
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