12 CAPM Estimate of the Cost of Equity Capital Voice River, Inc has successfully moved through its early life cycle stages and now is well into its rapid growth stage However by traditional standards this provider of media on demand is still considered to be a relatively small venture The interest rate on long term U S government securities is currently 7 percent Voice Rivers management has observed that over the long run the average annual rate of return on small firm stocks has been 17 3 percent while the annual returns on long term U S government securities has averaged 5 7 percent Management views Voice River as being an average small company venture at its current life cycle stage Determine the historical average annual market risk premium for small firm common stocks Use the capital asset pricing model (CAPM) to estimate the cost of common equity capital for Voice River 13 Weighted Average Cost of Capital Voice River, Inc is interested in estimating its weighted average cost of capital (WACC) now that it is in its rapid growth stage Voice River has a $500,000, 10 percent interest, short term bank loan, a $1 5 million, 12 percent long term debt issue, and 42 million in common equity The venture is in a 35 percent income tax bracket A Determine the after tax costs of the bank loan and the long term debt issue B Calculate the WACC for Voice River, Inc , using the cost of common equity capital estimated in Problem 12 14 Weighted Average Cost of Capital Refer to Problem 13 for Voice River, Inc Estimate the WACC if the cost of common equity capital is 20 percent Estimate the WACC if the cost of common equity capital is at the representative target rate of 25 percent for typical ventures in their late rapid growth life cycle state

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12. [CAPM Estimate of the Cost of Equity Capital] Voice River, Inc. has successfully moved through its early life cycle stages and now is well

12. [CAPM Estimate of the Cost of Equity Capital] Voice River, Inc. has successfully moved through its early life cycle stages and now is well into its rapid growth stage. However by traditional standards this provider of media-on-demand is still considered to be a relatively small venture. The interest rate on long-term U.S. government securities is currently 7 percent. Voice Rivers management has observed that over the long-run the average annual rate of return on small firm stocks has been 17.3 percent while the annual returns on long-term U.S. government securities has averaged 5.7 percent. Management views Voice River as being an average small company venture at its current life cycle stage.

Determine the historical average annual market risk premium for small firm common stocks.

Use the capital asset pricing model (CAPM) to estimate the cost of common equity capital for Voice River.

13. [Weighted Average Cost of Capital]

Voice River, Inc. is interested in estimating its weighted average cost of capital (WACC) now that it is in its rapid growth stage. Voice River has a $500,000, 10 percent interest, short-term bank loan, a $1.5 million, 12 percent long-term debt issue, and 42 million in common equity. The venture is in a 35 percent income tax bracket.

A. Determine the after-tax costs of the bank loan and the long-term debt issue.

B. Calculate the WACC for Voice River, Inc., using the cost of common equity capital estimated in Problem 12.

14. [Weighted Average Cost of Capital]

Refer to Problem 13 for Voice River, Inc.

Estimate the WACC if the cost of common equity capital is 20 percent.

Estimate the WACC if the cost of common equity capital is at the representative target rate of 25 percent for typical ventures in their late rapid-growth life cycle state.