O.K., Inc. uses one-third debt and two-thirds common stock to finance their oper
ID: 2714738 • Letter: O
Question
O.K., Inc. uses one-third debt and two-thirds common stock to finance their operations. The after-tax cost of debt is 4.5 percent and the cost of equity is 9 percent. The management of O.K., Inc. is considering a small project that they consider to be equally as risky as the overall firm. The project has an initial cash outlay of $10,000. The project is expected to have a single cash inflow of $17,500 at the end of two years. What is the projected net present value of this project? Answers: $5,040.41, $5,143.32, $5,707.07, $6,025.27, $6,279.07
Explanation / Answer
WACC = Wd×Rd×(1-t)+ We×Ke
W is weights of respective portfolios
R is return on respective portfolios
= (1÷3)×4.5%+ (2÷3)×9%
= 7.5%
NPV = PV of cash inflows-Present value of cash outflows
= $17,500×(1÷(1+7.5%)^2)-$10,000
= $5,143.32
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