lOMoARcPSD|3013804
Mini case chapter 9 - Juan N
Accouting (Bethune-Cookman University)
, lOMoARcPSD|3013804
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 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.
● Jana’s common stock is currently selling at $50 per share. Its last dividend (D0) was $3.12
(4.19), and dividends are expected to grow at a constant rate of 5.8% (5) in the foreseeable
future. Jana’s beta is 1.2, the yield on T-bonds is 5.6% (7), 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% (4) risk premium.
● Jana’s 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.
a. 1. What sources of capital should be included when you estimate Jana’s weighted average
cost of capital?
The WACC is used primarily for making long-term capital investment decisions, i.e., for
capital budgeting. Thus, the WACC should include the types of capital used to pay for long-
term assets, and this is typically long-term debt, preferred stock (if used), and common
stock. Short-term sources of capital consist of (1) spontaneous, noninterest-bearing
liabilities such as accounts payable and accruals and (2) short-term interest-bearing debt,
such as notes payable. If the firm uses short-term interest-bearing debt to acquire fixed
assets rather than just to finance working capital needs, then the WACC should include a
short-term debt component. Noninterest-bearing debt is generally not included in the cost
of capital estimate because these funds are netted out when determining investment
needs, that is, net rather than gross working capital is included in capital expenditures.
Mini case chapter 9 - Juan N
Accouting (Bethune-Cookman University)
, lOMoARcPSD|3013804
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 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.
● Jana’s common stock is currently selling at $50 per share. Its last dividend (D0) was $3.12
(4.19), and dividends are expected to grow at a constant rate of 5.8% (5) in the foreseeable
future. Jana’s beta is 1.2, the yield on T-bonds is 5.6% (7), 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% (4) risk premium.
● Jana’s 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.
a. 1. What sources of capital should be included when you estimate Jana’s weighted average
cost of capital?
The WACC is used primarily for making long-term capital investment decisions, i.e., for
capital budgeting. Thus, the WACC should include the types of capital used to pay for long-
term assets, and this is typically long-term debt, preferred stock (if used), and common
stock. Short-term sources of capital consist of (1) spontaneous, noninterest-bearing
liabilities such as accounts payable and accruals and (2) short-term interest-bearing debt,
such as notes payable. If the firm uses short-term interest-bearing debt to acquire fixed
assets rather than just to finance working capital needs, then the WACC should include a
short-term debt component. Noninterest-bearing debt is generally not included in the cost
of capital estimate because these funds are netted out when determining investment
needs, that is, net rather than gross working capital is included in capital expenditures.
