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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