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 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 firm’s tax rate is 40%.
• The current price of Jana’s 12% coupon, semiannual payment, noncallable bonds with 15 years remaining 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.
• The current price of the firm’s preferred stock is $116.95. The annual dividend is 10% of $100 par value. Jana would incur flotation costs equal to 5% of the proceeds on a new issue.
• Jana’s common stock is currently selling at $50 per 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%.
• Jana’s target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.
What sources of capital should be included when you estimate Jana’s weighted average cost of capital?
What is the market interest rate on Jana’s debt, and what is after tax cost of this debt for WACC purposes?
What is the firm’s cost of preferred stock?
Using the CAPM approach, what is Jana’s estimated cost of equity?
What is the estimated cost of equity using the dividend growth approach?
What is Jana’s weighted average cost of capital (WACC) from step (4)? What factors influence a company’s WACC?