Question

Time Warner shares have a market capitalization of

$60

billion. The company is expected to pay a dividend of

$0.40

per share and each share trades for

$30.

The growth rate in dividends is expected to be

5​%

per year. ​ Also, Time Warner has

$15

billion of debt that trades with a yield to maturity of

9​%.

If the​ firm's tax rate is

40​%,

what is the​ WACC?  

Answer 1

Given,

Equity = $60 billion

Expected dividend = $0.40

Share price = $30

Growth rate = 5% 0.05

Debt = $15 billion

Yield to maturity = 9%

Tax rate = 40% or 0.40

Solution :-

Cost of equity = (expected dividend/share price) + growth rate

= ($0.40/$30) + 0.05

= 0.01333333333 + 0.05 = 0.06333333333 or 6.333333333%

Total value = equity + debt

= $60 + $15 = $75 billion

Weight of equity = equity/total value

= $60 billion/$75 billion = 0.8

Weight of debt = debt/total value

= $15 billion/$75 billion = 0.2

After tax cost of debt = yield to maturity x (1 - tax rate)

= 9% x (1 - 0.40)

= 9% x 0.60 = 5.40%

Now,

WACC = (cost of equity)(weight of equity) + (after tax cost of debt)(weight of debt)

= (6.333333333%)(0.8) + (5.40%)(0.2)

= 5.0666666664% + 1.08% = 6.15%