During the last few years, Jana Industries has been tooconstrained by the high cost of capital to make many capitalinvestments. Recently, though, capital costs have been declining,and the company has decided to look seriously at a major expansionprogram that had been proposed by the marketing department. Assumethat you are an assistant to Leigh Jones, the financialvice-president. Your first task is to estimate Jana's cost ofcapital. Jones has provided you with the following data, which shebelieves may be relevant to your task:

Information:

1. The firm's tax rate is 40 percent.

2. The current price of Harry Davis’ 12 percent coupon,semiannual payment, noncallable bonds with 15 years remaining tomaturity is $1,153.72. Jana's does not use short-terminterest-bearing debt on a permanent basis. New bonds would beprivately placed with no flotation cost.

3. The current price of the firm's 10 percent, $100 par value,quarterly dividend, perpetual preferred stock is $116.95. Janawould incur flotation costs equal to 5% per share on a newissue.

4. Jana’s common stock is currently selling at $50 per share.Its last dividend (d0) was $3.12, and dividends are expected togrow at a constant rate of 5.8 percent in the foreseeable future.Jana’s beta is 1.2; the yield on t-bonds is 5.6 percent; and themarket risk premium is estimated to be 6 percent. For thebond-yield-plus-risk-premium approach, the firm uses a 3.2percentage point risk premium. 5. Harry Davis’ target capitalstructure is 30 percent long-term debt, 10 percent preferred stock,and 60 percent common equity.

5. Jana's target capital structure is 30% long-term debt, 10%preferred stock, and 60% common equity.

Problems:

A. What is the firms cost of preferred stock?

B. Jana's preferred stock is riskier to investors than its debt,yet the preferred stock's yield to investors is lower than theyield to maturity on the debt. Does this suggest that you have madea mistake? (hint think about taxes)

C. What is the estimated cost of equity using the discountedcash flow approach