1. You are in inventor whose patent is used in manufacturing of a pain management drug. As a result, you are getting a stream of royalties, and your royalties will end at the time of the patent expiration 5 years from now. You collect your royalty payments at the end of each year. You expect that at the end of the current year the royalty payment will be $10,000. After that, you estimate that the growth in royalty payments to be low, at 1% per year, due to increased competition. You are considering selling your royalty payment stream, potentially to the maker of the drug, Pharma Corp., which is a large publicly traded company. Pharma Corp. is financed with both debt and equity. The market value of equity is $100M, and the book value of debt is $50M. The beta of equity is 2. The risk-free rate is 2% and the expected market risk premium is 5%. Assume that the beta of corporate debt is 0.25.

1. What discount rate should Pharma Corp. be using when valuing your royalty stream?