Question 3

Mentari Jaya 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 Malaysian government securities is currently 7 percent. The management has observed that the long-run average annual rate of return on small firm stocks has been 17.3 percent while the annual returns on long-term Malaysian government securities has averaged 5.7 percent. Management views Mentari Jaya as being an average small company venture at its current life cycle stage.

(i) Calculate the historical average annual market risk premium for small firm common stocks.

(ii) Use the Capital Asset Pricing Model (CAPM) to estimate the cost of common equity capital for Mentari Jaya.