The Neptune Company offers network communications systems to computer users. The company is planning a major investment expansion but is unsure of the cost of equity capital as it has no publicly-traded equity. Your assignment is to determine an appropriate equity cost. List and explain the steps you will need to take to complete this assignment.
What will be an ideal response?
Step 1: Collect estimates of equity betas for firms in the same business as Neptune.
Step 2: Collect market values and debt-equity ratios for each business in Step 1.
Step 3: De-lever the individual equity betas and estimate an average asset beta for the group.
Step 4: Re-lever the average asset beta using Neptune's target debt-equity ratio to determine Neptune's equity beta.
Step 5: Determine the risk-free rate and the market risk premium.
Step 6: Calculate the estimated cost of equity capital using Neptune's estimated equity beta.
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