Time Warner shares have a market capitalization of $50 billion.The company is expected to pay a dividend of $0.30 per share and each share trades for $30.The growth rate in dividends is expected to be 7% per year.Also,Time Warner has $15 billion of debt that trades with a yield to maturity of 8%.If the firm's tax rate is 30%,what is the WACC?

Question

Quizplus · Accepted Answer

To calculate WACC, we need to find the cost of equity and the cost of debt.

Cost of Equity:
The cost of equity can be found using the dividend discount model:
D1 = D0(1+g) = 0.30(1+0.07) = 0.321
Re = (D1 / Stock Price) + g
Re = (0.321 / 30) + 0.07 = 0.0817 or 8.17%

Cost of Debt:
The cost of debt is given as the yield to maturity, which is already a pre-tax cost. We need to adjust it for taxes:
After-tax cost of debt = 8% × (1 - 0.30) = 5.6%

Weight of Equity:
Market value of equity = Number of shares × Stock Price
Market value of equity = 50 billion / 30 = 1.67 billion shares
Market value of equity = 1.67 billion × 30 = $50.1 billion
Weight of equity = (Market value of equity / Total value) × 100
Weight of equity = (50.1 billion / (50.1 billion + 15 billion)) × 100
Weight of equity = 76.95%

Weight of Debt:
Weight of debt = (Market value of debt / Total value) × 100
Market value of debt = 15 billion
Total value = 50.1 billion + 15 billion = 65.1 billion
Weight of debt = (15 billion / 65.1 billion) × 100
Weight of debt = 23.05%

WACC:
WACC = (Weight of equity × Cost of equity) + (Weight of debt × Cost of debt)
WACC = (76.95% × 8.17%) + (23.05% × 5.6%)
WACC = 6.3% + 1.29%
WACC = 7.45%

Therefore, the WACC is 7.45%. The best choice is C.

Time Warner Shares Have a Market Capitalization of $50 Billion