Assume Time Warner shares have a market capitalization of $60 billion. The company is expected to pay a dividend of $0.30 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 8%. If the firm's tax rate is 35%, compute the WACC

WACC = 7.2%

Explanation:

Weighted average cost of capital is the average cost of all of the long-term types of finance used by a company weighted according to the that amount of finance used in relation to the total pool of fund

To compute the WACC, we will follow the steps below:

Step 1

Calculate the cost of the individual sources of finance:

Cost of debt = Before-tax deb * (1-T)

= 8% * (1-0.35)

= 5.2%

Cost of equity = (Do (1+g) / Po) + g

= (0.30 (1+0.07) / 40) + 0.07

= 7.8%

Step 2

Calculate the market value of the individual sources of finance

Equity = $60 billion

Debt = $20 billion

Step 3

Calculate WACC

= 7.8% * 80 billion = 4.6815

= 5.2% * $ 20 billion = 1.04

Total value of debt and equity = 60 + 20 = $80 billion

WACC = (4.68 + 1.04) / 80 * 100

= 7.2%

WACC = 7.2%