Pan American Airlines\' shares are currently trading at $65.6465.64 each. The ma
ID: 2800330 • Letter: P
Question
Pan American Airlines' shares are currently trading at
$65.6465.64
each. The market yield on Pan Am's debt is
66%
and thefirm's beta is
1.21.2.
The T-Bill rate is
3.53.5%
and the expected return on the market is
9.259.25%.
The company's target capital structure is
7070%
debt and
3030%
equity. Pan American Airlines pays a combined federal and state tax rate of
3838%.
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
$2.392.39
per share was paid yesterday. Pan Am started paying dividends
33
years ago. The first dividend was
$1.441.44
per share.
Employing the constant growth dividend discount model, the estimated cost of common equity for Pan Am is
nothing%.
(Round to two decimal places.)
Explanation / Answer
Dividend paid three year ago was = $1.44
Current Dividend = $2.39
Growth rate in dividend = [($2.39 / $1.44) ^ (1 / 3)] - 1
= (1.6597 ^ 0.33) - 1
= 1.1840 - 1
= 18.40%.
Growth rate in dividend in last three year is 18.40%.
Current Stock price = $65.64
Cost of equity using constant growth model is calculated below:
Cost of equity = [Current Dividend × (1 + Growth rate) / Current Stock price] + Growth rate
= [$2.39 × (1 + 18.40%) / $65.64] + 18.40%
= ($2.83 / $65.64) + 18.40%
= 4.31% + 18.40%
= 22.71%
Cost of equity using constant growth model is 22.71%.
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