During the last few years, Jana Industries has been to constrained by the high cost of capital to make many capital investments. Recently, though, capital cost 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 assistant to Leigh Jones, the financial vice president. Your first task is to estimate Jana's cost of capital. jones has provided you with the following data, which she believes may be relevant to your task:
* The frims tax rate is 40%
* The current price of Jana's 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturigy is $1,153.72. Jana does not use short-term interest-bearing debt on a permanet basis. New bonds would be privatley place with no flotation cost.
*The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Jana would incur flotation cost equal to 5% of the proceeds on a new issue.
* Jana's common stock is currently seling at $50 per share. Its last dividend was $3.12, and dividends ar expected to grow at a constant rate of 5.8% in teh foreseeable future. Jana's beta is 1.2, the yeildon T-Bonds is 5.6%, and the market risk premium is estimated to be 6%. For the own-bond-yield-plus-judgmental-risk-premium approach, the firm uses a 3.2% capital risk premium.
* Jana's target capital sructure is 30% long-term debt, 10% preferred stock, and 60% common equity.
To help you structure the task, Leigh Jones has asked you to anser the following questions:
a (1) What sources of capital should be included when you estimate Jana's weighted average cost of capital?
(2) Should the componet cost be figured on a before tax or after-tax basis?
(3) Should the cost be historical (embedded) cost or new (marginal) cost?
D (1) What are the two primary ways companies raise common equity?
(2) Why is there a cost associated with reinvested earnings?
(3) Jana doesn't plan to issue new shares of common stock. Using the CAPM approach, what is Jana's estimated cost of equity?
E (1) What is the estimated cost of equity using the dividend growth approach?
(2) Suppose the frim has a historically earned 15% on equity (ROE) and has paid out 62% of earnings, and suppose investors expect similar values to obtain in the future. How could you use the information to estimate the future dividend growthrate, and what growth rate would you get? Is this consistent with the 5.8% growth rate given earlier?