Question

. You are trying to estimate the cost of capital to use in assessing a new investment

venture in the entertainment business, for TechSmith Inc, a publicly traded

electronics company. You have been provided the following information:

            • The beta for TechSmith, based upon stock prices for the last 5 years, is 1.65 but

the unlevered beta for entertainment companies is 1.08.

            • At the moment, TechSmith has one bank loan outstanding, with a principal

payment due of $100 million at the end of 10 years and interest payments of $5

million every year for the next 10 years.

                        - TechSmith also has lease commitments of $50 million a year, due at the end of each year for the next 6 years.

            • TechSmith has 75 million shares outstanding, with a stock price of $15/share.

            • TechSmith has a bond rating of Baa, with a default spread of 3.5% over the risk

free rate.

                        - The marginal tax rate is 40% but TechSmith’s effective tax rate is 25%.

• The riskfree rate is 2.7% and the equity risk premium is 5.8%.

a. Estimate the market value of the interest bearing debt.

b. Estimate the debt value of lease commitments.

c. Estimate the cost of capital for this project, assuming that it will be funded using the same debt ratio that TechSmith uses today.

Answer 1