During the last few years, Jana Industries has been too constrained by the high costof 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 Janas cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task:

The firms tax rate is 25%.

The current price of Janas 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. There are 70,000 bonds. 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 firms 10%, $100 par value, quarterly dividend, perpetual pre- ferred stock is $116.95. There are 200,000 outstanding shares. Jana would incur flota- tion costs equal to 5% of the proceeds on a new issue.

Janas common stock is currently selling at $50 per share. There are 3 million outstanding common shares. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Janas beta is 1.2, the yield on 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% risk premium. To help you structure the task, Leigh Jones has asked you to answer the following questions:

1.What is the firms cost of preferred stock?

2. Janas preferred stock is riskier to investors than its debt, yet the preferred stocks yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake? (Hint: Think about taxes.)

3. Jana doesnt plan to issue new shares of common stock. Using the CAPM approach, what is Janas estimated cost of equity?

4. What is the estimated cost of equity using the dividend growth approach?

5. Suppose the firm has 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 this information to estimate the future dividend growth rate, and what growth rate would you get? Is this consistent with the 5.8% growth rate given earlier?

6. What is your final estimate for the cost of equity, rs?

7. Use Janas target weights to calculate the weighted average cost of capital (WACC).

8. Janas target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. How does this compare with the current market value capital structure?

9. Jana is interested in establishing a new division that will focus primarily on develop- ing new Internet-based projects. In trying to determine the cost of capital for this new division, you discover that specialized firms involved in similar projects have, on average, the following characteristics: Their capital structure is 10% debt and 90% common equity; their cost of debt is typically 12%; and they have a beta of 1.7. Given this information, what would your estimate be for the new divisions cost of capital?