Question A2

Part I iCloud is a young venture company specializing in cloud computing services. As with sales, dividends are expected to grow at an annual rate of 30, 20 and 15 percent for the next three years respectively. Afterwards, the dividend growth rate is expected to stabilize at a constant rate of 10 percent in the foreseeable future. Last week, the company just paid an annual dividend of $0.80 per share.

iClouds stock beta coefficient is 2.0. The risk-free rate is 7 percent and the expected rate of return on the market is 16 percent.

Required: (a) What is the expected rate of return on iClouds stock based on CAPM? (2 marks)

(b) What is the stock value three years from now? (3 marks) (c) What is the stock value today? (2 marks)

(d) What are the expected dividend yield and capital gain yield today? (2 marks)

Part II

Larry, Chief Financial Officer of HTML Corporation, just hired you as a Finance Manager to review the capital structure of the company and estimate its cost of capital.

An extract of the capital structure on the Statement of Financial Position of HTML Corporation for the year ended December 31, 2019 is shown as below:

Statement of Financial Position Total

($) Bonds (semi-annual 6% coupon rate, $1,000 par, 10 years to maturity) 3,000,000

Preferred stock ($100 par, 6% dividend) 900,000

Common stock ($8 par) 784,000

Total4,684,000

Market prices per bond/share are $840 for bonds, $96 for preferred stock, and $14 for common stock respectively.

Dividends just paid for common stock were $2.80 per share last year and are projected to have an annual growth rate of 5% indefinitely. The firm is in a 34% tax bracket.

Question A2 (continued) Required:

(a) Based on the financial statement, the annual interest expense per bond is $60 and the market price is $840. Therefore, Larry concludes that our cost of debt is obviously $60 / $840 = 7.14%. Do you agree with his estimation? Explain your answer within 150 words. (6 marks)

(b) Based on the above data, Larry argues that It costs us $2.80 dividend per share to use shareholders fund last year. The cost of common stock should be $2.80 (1+5%) / $14 = 21% this year. Besides, this cost is also the same regardless of using internal equity or issuing public shares. Do you agree with Larrys conclusion? Explain your answer within 150 words. (5 marks)

(c) Compute HTMLs weighted average cost of capital (WACC). (15 marks)

Part II PLEASE