Pan American Airlines’ shares are currently trading at $69.25 each. Th

Pan American Airlines’ shares are currently trading at $69.25 each. The yield on Pan Am’s debt is 4% and the firm’s beta is 0.7. The T-Bill rate is 4% and the expected return on the market (E (kM)) is 9%.

The company’s target capital structure is 25% debt and 75% equity. Pan American Airlines pays a combined federal and state tax rate of 35%. What is Pan Am’s cost of equity?
A) 7.0%
B) 7.5%
C) 8.0%
D) 8.5%
E) 9.0%

ANSWER

B