Time Warner, the company that owns New Line Cinema, has a beta on its stock (TWC

Question

Time Warner, the company that owns New Line Cinema, has a beta on its stock (TWC) of 1.15. Over the long-term, the risk-free rate of interest has been around 3% and the return on the market (S&P;) has been around 11%. Time Warner's cost of debt is approximate 5% and its corporate tax rate is around 32%. Time Warner has about dollar 24 billion in net debt and dollar 42 billion in equity. The current price of Time Warner's stock is around dollar 70. Use this infomation to answer the following two questions. Calculate warner Brother's weighted aerage cost of capital.

Explanation / Answer

Step 1:

1) Cost of Common Stock = Rf + (Rm-Rf)*Beta

Cost of Common Stock = 3 + (11-3)*1.15

Cost of Common Stock = 12.20%

2) After Tax Cost of Debt = 5*(1-32%)

After Tax Cost of Debt = 3.40%

Step 2:

Debt = $ 24 billion

Equity = $ 42 billion

Total Value = $ 66 Billion

Weight of Common Stock = 42/66

Weight of Debt = 24/66

Step3:

WACC = Weight of Common Stock* Cost of Common Stock Weight of Debt* After Tax cost of Debt

WACC = 42/66 * 12.20 + 24/66*3.40

WACC = 9 %

Answer

WACC = 9 %

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