(Adds details on expanded refund policy, context, prime minister and shareholder comments) April 13 (Reuters) - Air Canada shares fell sharply on Tuesday on fears that its market value would be diluted after the Canadian government took a discounted equity stake in the flagship carrier as part of a deal for C$5.9 billion ($4.7 billion) in aid. But analysts and investors said Air Canada’s decision to accept the bigger-than-expected aid package, which was announced on Monday, was the right decision for Canada’s largest carrier to ride out the crippling downturn in air travel caused by the coronavirus pandemic. The deal gives Ottawa a roughly 6% stake in Canada’s largest carrier at a discount of 14%, which prompted several analysts to cut their price targets. “We believe some investors could be negatively surprised by equity dilution and a repayable loan for refunds,” Scotiabank Konark Gupta wrote in a note, while reiterating a “sector perform” rating on the stock. Air Canada shares opened more than 4% higher before sinking about 6.7%. They were last down about 2.8% at C$26.25 on the Toronto Stock Exchange. Canada is wrestling with soaring COVID-19 cases driven by the new coronavirus variants and a comparatively slower vaccination rollout than in the United States, raising questions about the reopening of air travel. That could put pressure on Canadian authorities to maintain crippling temporary restrictions, such as a three-day hotel quarantine for arriving passengers which airline executives have said should be phased out ahead of the summer season. “The bigger issue for AC and its investors is the timing around the vaccine rollout and eventual lifting of travel restrictions, as most markets that have reopened show strong pent-up demand,” Raymond James analyst Savanthi Syth said in a note. Prime Minister Justin Trudeau on Tuesday praised the deal with Air Canada as “good and fair.” TD Securities analyst Tim James described the funding as providing a backstop for the carrier. “We believe that Air Canada’s access to this capital will prove to be insurance as opposed to necessary liquidity required to finance operations or capital expenditures in 2021 and beyond,” James wrote in a note in which he cut his target price on Air Canada to C$29 from C$31, while reaffirming a “hold” rating. Canada’s government also is engaged in aid talks with WestJet Airlines and Transat AT. Air Transat, which has suspended flights until June due to pandemic guidelines, has said it needs at least C$500 million in financing this year. “While we expect similar negotiations at competitors, the longer things drag on, the tougher it will be on AC’s Canadian competitors,” Syth said. Peter Letko, senior vice president at Letko Brosseau and Associates, which is an Air Canada shareholder, said the government deal “removes worries” amid concerns that the pandemic could drag on. Air Canada also said it would ease restrictions on future refunds for passengers, a key part of the government talks. The agreement - the largest individual coronavirus-related loan that Ottawa has arranged with a company - was announced after the airline industry criticized Trudeau’s Liberal government for dawdling.