O.K., Inc. uses one-third debt and two-thirds common stock to ﬁnance its 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?

Question

Quizplus · Accepted Answer

The weighted average cost of capital (WACC) is calculated as (1/3 * 4.5%) + (2/3 * 9%) = 7.5%. The NPV is calculated using this WACC as the discount rate: NPV = -$10,000 + $17,500 / (1 + 0.075)^2 = $5,143.32.

OK, Inc Uses One-Third Debt and Two-Thirds Common Stock to ﬁNance