Pan American Airlines\' shares are currently trading at $71.62 each. The market

Question

Pan American Airlines' shares are currently trading at $71.62 each. The market yield on Pan Am's debt is 8% and the firms beta is 1.1. The T-Bill rate is 3.5% and the expected return on the market is 8%. The company's target capital structure is 70% debt and 30% equity. Pan American Airlines pays a combined federal and state tax rate of 40%. What is the estimated cost of common equity, employing the constant growth dividend discount model? Assume that Pan Am pays annual dividends and that the last dividend of $2.35 per share was paid yesterday. Pan Am started paying dividends 6 years ago. The first dividend was $1.67 per share.

Explanation / Answer

Cost of common equity = Risk free return + Beta (Market return - Risk free return)

= 3.5%+1.10(8%-3.5%) i.e 8.45%

After tax cost of debt = 8%*0.60 i.e 4.80%

Weighted average cost of capital = 4.80*0.70+8.45*0.30 i.e 5.895%

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.