During the last few years, Jana Industries has been too constrained by the high cost of capital to make many capital investments.
Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program proposed by the marketing department.
Assume that you are an assistance to Leigh Jones, the finanical vice president. Your first tak is to testimate Jana's cost of cpital. Jones has procided you with the following data, which she believe may be relecant to your task:
1.) The firm's tax rate is 40%
2.) The current price of Jana's 12% coupon, semiannual payment, noncallable bonds with 15 years reamining to maturity is $1,153.72.
Jana does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost.
3.) The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Jana would incur flotation costs equal to 5% of the proceeds on a new issues.
4.) Jana's common stock is currently sellings at $50/share. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future.
Jana's beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%. For the over-own-bond-yield-plus judgetmental-risk-premium approach, the firm uses a 3.2% risk premium.
5.) Jana's target capital structure is 30% long debt, 10% preferred stock, and 60% commong equity.
a.) What sources of capital should be included when you estimate Jana's WACC?
Should the componenent costs be figured on a before-tax or an after tax basis?
Should the costs be historical costs or new costs?
b.) What is the market interest rate on Jana's debt, and what is the component cost of this debt for WACC purposes?
c.) What is the firm's cost of preferred stock?
Jana's preferred stock is riskier to investors than its debt, yet the preferred's yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake?
d.) What are the two primary ways companies raise common equity?
Why is there a cost associated with reinvested earnings?
Jana doesn't plan to issue new shares of common stock. Using the CAPM approach, what is Jana's estiamted cost of equity?
e.) What is the estimated cost of equity using the discounted cash flow approach?
Suppse the firm has historically earned 15% on equity and has paid out 62% of earnings, and supposed investors expect similar values to obtain the future.
How could you use this information to estimate the furture dividend growth rate, and what growth rate would you get? Is this consistent with the 5.8% growth rate given earlier? Could the DCF method be applied if the growth rate were not constant? How?
f.) What is the cost of equity based on the over-own-bond-yield-plus-judgmental-risk-premium mothhod?
g.)What is your final estimate for the cost of equity, rs?
h.) What isjana weighted average cost of capital?