Assume Time Warner shares have a market capitalization of $40 billion. The company is expected to pay a dividend of $0.25 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 9%. If the firm's tax rate is 40%, what is the WACC?

Question

Quizplus · Accepted Answer

C) Cost of equity is the next period dividend divided by the price plus the growth rate in dividends. Cost of debt is the yield to maturity times one minus the tax rate. WACC is the weight of debt times cost of debt plus weight of equity times cost of equity.
Cost of equity = ($0.25 / $40) + 0.07 = 0.07625 or 7.63%;
Cost of debt = 0.09 × (1 - 0.4) = 0.054 or 5.4%;
WACC = ($40 billion × 0.07625) / $60 billion + ($20 billion × 0.054) / $60 billion = 0.0688 or 6.88%

Assume Time Warner Shares Have a Market Capitalization of $40