Question

Time Warner shares have a market capitalization of $ 45 billion. The company just paid a dividend of $ 0.25 per share and each share trades for $ 35. The growth rate in dividends is expected to be 8​% per year. ​ Also, Time Warner has $ 10 billion of debt that trades with a yield to maturity of 7​%. If the​ firm's tax rate is 40​%, compute the​ WACC?

Answer 1

WACC = 7.89%

Step-by-step explanation:

Lets find "cost of equity" first.

The formula is:

`k_e=(D_1)/(P_0)+g`

Which is basically the next year dividend divided by stock price summed with growth rate. So cost of equity is:

`k_e=(0.25)/(35)+0.08=0.0871`

Now, "cost of debt":

Formula is:

`k_d=YTM(1-T)`

Which is the yield to maturity times "1 - tax rate", so it will be:

`k_d=0.07(1-0.4)=0.042`

WACC formula is:

`WACC=W_e*k_e+W_d*K_d`

Where

W_e is weight of equity, which is 45/(45+10) = 45/55 = 9/11

W_d is weight of debt, which is 10/(45+10) = 10/55 = 2/11

Now, wacc is:

`WACC=0.0871*(9)/(11)+0.042*(2)/(11)=0.0789`

In percentage, 0.0789 * 100 = 7.89%

WACC = 7.89%