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 firmʹs tax rate is 40%, what is the WACC?

6.83%

Explanation:

For the computation of WACC first we need to follow some steps which is shown below:-

Step 1

Price = Dividend ÷ Cost of equity - Growth rate

= $40 = $0.25 ÷ (Cost of equity - 0.07)

Cost of equity = 7.625 %

Step 2

Cost of Debt

After cost of debt = Yield × (1 - Tax)

= 0.09 × ( 1 - 0.40)

= 5.40%

and finally,

WACC = (Cost of debt × Weight of debt) + (Cost of equity × Weight of equity)

= (5.40% × $20 ÷ $60) + (7.625% × $40 ÷ $60)

= 0.018 + 0.050833333

= 6.883333333

or

= 6.83%

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