Blowis shares are currently trading at $71.62 each. The market yield on Pan Am\'
ID: 2732079 • Letter: B
Question
Blowis shares are currently trading at $71.62 each. The market yield on Pan Am's debt is 8% and thr firm's 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. Blowis paya combined federal and state tax rate of 40%. What is the estimated cost of common equity, employing the constant growth dividend discount model? Assume they pay dividends and that the last dividend of $2.35 per share was paid yesterday. They started paying dividends 6 years ago. The first dividend was $1.67 per share.
Explanation / Answer
D 6 = D1(1+g)^n
2.35 = 1.67 (1+g)^5
2.35 /1.67 = (1+g)^5
1.40719 = (1+g)^5
1+g = (1.40719)^1/5
1+g = 1.0707
g = 1.0707- 1 = .0707 or 7.07%
Cost of equity = [D6(1+g) / current price ] +g
= 2.35 (1+.0707) / 71.62 ] +.0707
=[ 2.35 *1.0707 / 71.62 ] + .0707
= .0351+ .0707
= 10.58%