Question

South American Airlines' (SAA) shares are currently trading at $69.25 each. The yield on the company’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. The company pays a combined income tax rate of 35%. The GST rate is 13%. What is SAA’s cost of equity? 11. Using the information outlined in #11, calculate SAA’s cost of debt (after tax). 12. What is SAA’s weighted average cost of capital? 13. What does SAA’s weighted average cost of capital mean? Describe it in your own words 14. SAA’s key rival, Andrew Airlines has a 7 percent preferred stock outstanding that is currently selling for $48 a share. The preferred stock has a $100 par value. The market rate of return is 10 percent and the firm's tax rate is 34 percent. GST is 13%. What is the Andrew’s cost of preferred stock?

Answer 1

South American Airlines:

1. Cost of Equity = Risk Free Rate + Beta * (market Rate - Risk Free Rate)

Cost of Equity = 4% + 0.70 * (9% - 4%)

Cost of Equity = 7.50%

2. Cost of Debt = Before tax Cost of Debt * (1 - Tax)

Cost of Debt = 4% * (1 - 0.35)

Cost of Debt = 2.60%

3. Weighted Average Cost of capital

4. What Does SAA WACC Mean? The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets

5. Cost of Preferred Stock = Dividend / Market Price = $7 / 48 = 14.58%