Following are income statements and balance sheets for a venture company for 2017 and 2018. Short-term bank loans are available at an 8% interest rate. The venture believes that the cost of obtaining long-term debt and equity capital will be somewhat higher. The real interest rate is estimated to be 2% and a long-run inflation premium is estimated at 3%. The interest rate on long-term government bonds is 7%. A default-risk premium on long-term debt is estimated at 6%; plus the firm is expecting to have to pay a liquidity premium of 3% due to the illiquidity associated with its long-term debt. The market risk premium on large-firm common stocks (beta =1) over the rate on long-term government bonds is estimated to be 6%. The firm expects that equity investors in their venture will require an additional investment risk premium estimated at two times the market risk premium on large-firm common stocks.

Estimate the weighted average cost of capital (WACC) using the book values of interest-bearing debt and stockholders equity capital at the end of 2018.

BALANCE SHEET 2017 2018 Cash Accounts receivable Inventories Total current assets Gross fixed assets Accumulated depreciation Net fixed assets Total assets $ 50,000 200,000 400.000 650,000 450,000 -100.000 350.000 $1,000,000 $ 20,000 280,000 500,000 800,000 540,000 -140,000 400,000 $1.200.000 Accounts payable Accruals Bank loan Total current liabilities Long-term debt Common stock (0.05 par) Additional paid-in-capital Retained earnings Total liabilities and equity $ 130,000 50,000 90.000 270,000 300,000 150,000 200,000 80.000 $1.000.000 $160,000 70,000 100,000 330,000 400,000 150,000 200,000 120,000 $1.200.000 INCOME STATEMENT Net sales Cost of goods sold Gross profit Marketing General and administrative Depreciation EBIT Interest Earnings before taxes Income taxes Net income (loss) 2017 $900,000 540,000 360,000 90,000 250,000 40.000 -20,000 45.000 -65,000 0 -$65,000 2018 $1,500,000 900,000 600,000 150,000 250,000 40,000 160,000 60,000 100,000 25,000 $ 75,000 BALANCE SHEET 2017 2018 Cash Accounts receivable Inventories Total current assets Gross fixed assets Accumulated depreciation Net fixed assets Total assets $ 50,000 200,000 400.000 650,000 450,000 -100.000 350.000 $1,000,000 $ 20,000 280,000 500,000 800,000 540,000 -140,000 400,000 $1.200.000 Accounts payable Accruals Bank loan Total current liabilities Long-term debt Common stock (0.05 par) Additional paid-in-capital Retained earnings Total liabilities and equity $ 130,000 50,000 90.000 270,000 300,000 150,000 200,000 80.000 $1.000.000 $160,000 70,000 100,000 330,000 400,000 150,000 200,000 120,000 $1.200.000 INCOME STATEMENT Net sales Cost of goods sold Gross profit Marketing General and administrative Depreciation EBIT Interest Earnings before taxes Income taxes Net income (loss) 2017 $900,000 540,000 360,000 90,000 250,000 40.000 -20,000 45.000 -65,000 0 -$65,000 2018 $1,500,000 900,000 600,000 150,000 250,000 40,000 160,000 60,000 100,000 25,000 $ 75,000