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 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 40%. The current price of Janas 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 firms 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 issue. Janas 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. 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. Janas target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. To help you structure the task, Leigh Jones has asked you to answer the following questions.

1. Should the company use its overall WACC as the hurdle rate for each of its divisions?

2. What procedures can be used to estimate the risk-adjusted cost of capital for a particular division? What approaches are used to measure a divisions beta?

3.Jana is interested in establishing a new division that will focus primarily on developing 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?

4. What are three types of project risk? How can each type of risk be considered when thinking about the new divisions cost of capital?

5. Explain in words why new common stock that is raised externally has a higher percentage cost than equity that is raised internally by retaining earnings.

6. (1) Jana estimates that if it issues new common stock, the flotation cost will be 15%. Jana incorporates the flotation costs into the dividend growth approach. What is the estimated cost of newly issued common stock, taking into account the flotation cost? (2) Jana issues 30-year debt with a par value of $1,000 and a coupon rate of 10%, paid annually. If flotation costs are 2%, what is the after-tax cost of debt for the new bond issue? p. What four common mistakes in estimating the WACC should Jana avoid?