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Nike announced plans to open a new shoe manufacturing plant. The CFO of Nike has asked you to compare two proposals for the plant. She
Nike announced plans to open a new shoe manufacturing plant. The CFO of Nike has asked you to compare two proposals for the plant. She wants you to select the plant which exceeds Nike's weighted average cost of capital (WACC) by the greatest amount using return as the measurement. To assist you in the capital project analysis, she has provided the following information: Cost of Capital Data -70% of Nike's capital base is equity, 30% is debt. Nike's tax rate is 30% -use the yield to maturity on Nike's 10 year bond as the cost of debt and the CAPM formula for the cost of equity -10 year Nike bond, $1,000 par value, 6% coupon pays annually, $1, 100 current bond price -beta = 1.5, risk free rate = 4%, expected total stock market return = 11% -cost of equity = risk free rate + beta(market return - risk free rate) Project Details -project A: cost is $700 million, first year cash flow = -$150 million, years 2 to 5 cash flows = $200 million per year, years 6 to 10 cash flows = $225 million per year, years 11 to IS cash flows = $250 million per year project B: cost is $500 million, first year cash flow = -$200 million, years 2 to 5 cash flows = $200 million per year, years 6 to 10 cash flows is 20% higher than years 2 to 5 cash flow, years 11 to 15 cash flows = $100 million per year Steps to Capital Budgeting Estimate cash (lows (CFs) Assess riskiness of CFs (use WACC (or all cash flow discounting in step 4); skip this step Determine the appropriate cost of capital |WACC) Find NPV and/or IRR; Accept if NPV > 0 and/or IRR > WACC If both projects were independent meaning you could do both, do they both meet the CFO's return hurdle? If both protects were independent meaning you could do both, are they both justified based on NPV alone
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