J.C. Penney's (JCPN.Q) traumatic transformation over the past year-and-a-half has resulted in spiraling losses and heavy capital expenditures. As a result, the company has burned through a substantial amount of cash. For fiscal year 2012, J.C. Penney posted non-GAAP free cash flow of negative $906 million.

Moreover, J.C. Penney recently disclosed that it had $821 million of cash as of early May, after having drawn $850 million from its revolving credit line. This indicates that the company consumed nearly $1 billion of cash during the quarter, as it funded operating losses, paid down accounts receivable, built up spring and summer inventories, and invested in store renovations. To address these liquidity issues, J.C. Penney expressed an interest in accessing the capital markets.

Late last month, J.C. Penney announced that it had reached an agreement for a $1.75 billion five-year term loan with Goldman Sachs. This loan would be secured by J.C. Penney's real estate, and provides a better source of long-term funding than the credit line. However, the new loan comes at a high cost, and will make it even harder for the company to return to profitability.

A small reprieve
While J.C. Penney's new loan is nominally for $1.75 billion, the company will only receive $1.3 billion in cash proceeds. There are several reasons for this. Most important, J.C. Penney has $254 million of outstanding debentures (a form of debt) that restrict its ability to issue new secured debt. In order to complete the new $1.75 billion loan, the company needs to buy out those debt holders.

As a result, it has offered a premium of as much as 45% to entice holders to sell their notes back to J.C. Penney. The company's tender offer will use up roughly $370 million of the capital raised. Furthermore, the new loan is being offered at a 1% discount to face value, and origination fees also cut into J.C. Penney's loan proceeds.

While J.C. Penney expects to reduce capital expenditures after the middle of this year, the company is still expected to post substantial losses for the foreseeable future. The new term loan should provide just enough liquidity to replace the $850 million currently drawn on J.C. Penney's credit line and fund the company's expected operating loss for the rest of this year. If losses continue significantly beyond that point, J.C. Penney will need to raise even more capital.

Costly debt
Moreover, the debt J.C. Penney issues will add to the company's interest expense, pressuring the bottom line. The loan is expected to price at a floating rate of approximately LIBOR plus 5.75%, with a minimum interest rate of 6.75%, according to Reuters. This implies annual interest expense of $118 million. This will be offset somewhat by the retirement of the debentures, which will save $18 million a year. On a net basis, J.C. Penney's annual interest expense will be $100 million higher for the next five years.

J.C. Penney can ill afford this additional expense, which is equal to about 0.8% of annual sales at the current run rate. While the company made significant cost cuts under Ron Johnson's leadership -- totaling at least $900 million annually -- these savings are gradually being offset by new costs. J.C. Penney is ramping up its marketing again, in order to convince customers to come back. Additionally, the company raised cash last year by selling REIT units that had previously provided steady cash flow for J.C. Penney. $100 million of incremental interest expense is just one more barrier to reaching breakeven.

Foolish bottom line
J.C. Penney absolutely needed the liquidity that will be provided by its new term loan. However, the price is very steep and will ultimately increase the company's interest expense by $100 million annually. This raises the company's breakeven point and will weigh down margins for the foreseeable future. With more and more lenders laying claim to their "piece" of J.C. Penney, shareholders are likely to lose out in the long run.