B D E G H b. What is the market Interest rate on Jana's debt and what is the component cost of this debt for WACC purposes? COST OF DEBT, N PV 5 PMT 6 FV -7 18 19 B-Tro 50 Tax rato 51 52 A-Trg (1 - Tax rate) 53 A-Trg- 54 55 A-T1 56 57 COST OF PREFERRED STOCK, Ips 58 C. (1.) What is the firm's cost of preferred stock? (B-T ra) 59 60 Pref. Dividend 61 Pref. Price 62 Flotation costs 63 64 65 66 67 Pref. Dividend + Pp (1 - F) + Tp. 11 13 Situation 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 that has been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to 0 estimate Jana's cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task: 12 (1) The firm's tax rate is 35%. 14 (2) The current price of Jana's 11% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Jana 15 does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. 16 (3) The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Jana would incur flotation 17 costs equal to 5% of the proceeds on a new issue. (4) Jana's common stock is currently selling at $50 per share. Its last dividend (D) was $3.10, 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 19 be 6%. For the own-bond-yield-plus-judgmental-risk-premium approach, the firm uses a 3% judgmental risk premium. 20 (5) Jana's target capital structure ls 35% long-term debt, 10% preferred stock, and 55% common equity. 22 To help you structure the task, Leigh Jones has asked you to answer the following questions 18 21 23 24 26 25 .. (1.) What sources of capital should be included when you estimate Jana's weighted average cost of capital (WACC)? 27 Answer: Bonds, Preferred Stock, and Common Stock 28 29 30 (2.) should the component costs be figured on a before-tax or an after-tax basis? 32 Answer: The component costs should be figured on an after-tax basis. 31 33 (3.) Should the costs be historical (embedded) costs or new (marginal costs? 37 Answer: The costs should be the new marginal costs. 38 39 b. What is the market interest rate on Jana's debt and what is the component cost of this debt for WACC purposes? 41 COST OF DEBT
