Cost of Equity
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 River’s 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.
1. Determine the historical average annual market risk premium for small firm common stocks.
Avg. historical MRP = (Avg. historical return) – (Avg. historical risk free rate) = ?
2. Use the capital asset pricing model (CAPM) to estimate the cost of common equity capital for Voice River.
Note that beta = 1, as against the small firm stocks = 1.
CAPM = (rf) + (MRP) x (B) = ?