E F G H B68 X & fx B D 78 COST OF EQUITY (INTERNAL), T, 79 d. (1.) What are the two primary ways companies raise common equity? 80 81 Answer: 82 83 (2) Why Is there a cost associated with reinvested earnings? 84 85 Answer: 86 87 88 (3.) Jana doesn't plan to issue new shares of common stock. Using the CAPM approach, what is Jana's estimated cost of equity? 89 90 The CAPM Approach 91 - Risk-free rate + (Market risk premium) (Beta) 92 r. Te+(RP.) b. (Note: RP, is the expected return on the market minus the risk-free rato.) 93 94 Risk-free rate 95 Expected market risk premium 96 Beta 97 98 res (RP) (b) 99 100 101 102 103 THE DISCOUNTED CASH FLOW APPROACH 104. (1.) What is the estimated cost of equity using the dividend growth approach? 105 108 The simplest dividend growth approach assumes that growth is expected to remain constant, and in this case: r. - D/P, +9. 107 100 P- D- 110 D, 112 D. P. 114 T, s 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 25 .. (1.) What sources of capital should be included when you estimate Jana's weighted average cost of capital (WACC)? 27 Answer: Bonda, Preferred Stock, and Common Stock 26 28 29 31 30 (2.) should the component costs be figured on a before-tax or an after-tax basis? 32 Answer: The component conts should be figured on an after-tax basis. (3.) Should the costs be historical (embedded) costs or new (marginal costs? 37 Answer: The costs should be the new marginal costs. 35 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, Chapter 11. WACC Case 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 estimate Jana's cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task: (1) The firm's tax rate is 35%. (2) The current price of Jana's 11% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Jana 5 does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. 6 (3) The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Jana would incur flotation 7 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 19 to 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 is 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 25 a. (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 26 28 29 30 31 (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. 33 34 35 (3.) Should the costs be historical (embedded) costs or new (marginal) costs? 36 37 Answer: The costs should be the new marginal costs. 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, 43 N 46 PV 15 (1,153.72)