Question

Pan American​ Airlines' shares are currently trading at​$70.65 each. The market yield on Pan​ Am's debt is 8​%and the​ firm's beta is

0.6.The​ T-Bill rate is 2​%and the expected return on the market is 6.5​%.

The​ company's target capital structure is 70​% debt and 30​% equity. Pan American Airlines pays a combined federal and state tax rate of 25​%.

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

4years ago. The first dividend was ​$1.78 per share.  

Employing the constant growth dividend discount​ model, the estimated cost of common equity for Pan Am is %.

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

$70.65 -N7000 Current price of share Last Dividend Dividend paid 4 years ago Annual dividend growth rate $1.78 7.19% Estimated cost of equity of Pan 10.76%

Cell reference -

B 70.65 2.35 Current price of share Last Dividend Dividend paid 4 years ago Annual dividend growth rate 1.78 =(C4/C5)^(1/4)-1 Estimated cost of equity of Pan =(C4*(1+C6)/C3)+C6

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.