Question

Assume Time Warner shares have a market capitalization of $60 billion. The company is expected to pay a dividend of $0.30 per share and each share trades for $40. The growth rate in dividends is expected to be 7% per year. Also, Time Warner has $20 billion of debt that trades with a yield to maturity of 8%. If the firm's tax rate is 35%, compute the WACC

Answer 1

Answer:

WACC = 7.2%

Explanation:

Weighted average cost of capital is the average cost of all of the long-term types of finance used by a company weighted according to the that amount of finance used in relation to the total pool of fund

To compute the WACC , we will follow the steps below:

Step 1

Calculate the cost of the individual sources of finance:

Cost of debt =   Before-tax deb × (1-T)

                    = 8% × (1-0.35)

                    = 5.2%

Cost of equity = (Do(1+g)/Po ) + g

                        = (0.30 (1+0.07)/ 40)   + 0.07

                        = 7.8%

Step 2

Calculate the market value of the individual sources of finance

Equity = $60 billion  

Debt = $20 billion

Step 3

Calculate WACC

            =  7.8% × 80 billion = 4.6815

            =    5.2% ×  $ 20 billion = 1.04

Total value of debt and equity = 60 + 20 = $80 billion

WACC =  (4.68  + 1.04)/ 80 × 100

         = 7.2%

WACC = 7.2%