MPF753 - Department of Finance - Digital Literacy - Case Study - Accounting - Assessment Answer

MPF753 - Department of Finance - Digital Literacy - Case Study - Accounting - Assessment Answer 

Task:

Learning Outcome

• Students will use the given assignment project to demonstrate their level and depth of learning in terms of both appropriateness as well as accuracy of the financial analysis tools/techniques used.
• Students will have to use information sources such as online financial databases, and also use electronic spreadsheets and other technologies as appropriate to collate, analyse and disseminate project output.

Dividend Discount Model

The dividend discount model is a well-known model for pricing equity shares using the time value of money concept whereby the current fair price of a share is evaluated as the present value of future expected dividends. In a relatively simple version of this model, it is assumed that the annual growth rate of dividends is constant and the current fair price of a share is obtained as next period’s dividend divided by the difference between the expected annual return on equity and the constant annual growth rate of dividends. When the current price of a share is already known (e.g. by looking up the publicly available market information on the share prices), the constant dividend growth model (also called Gordon’s model) can be inverted derive the annual return expected by the equity-holders of a certain stock. This is a methodology sometimes used to estimate the cost of equity capital for a firm. As your Assignment Part – 2 for MPF753-Finance in T2, 2019, you are required to apply Gordon’s
model in estimating the cost of equity capital of a firm using real data drawn from a financial database.

1. Choose three Australian listed companies (one each from three different sectors) that have been in business for at least the last fifteen years. Access Morningstar Datanalysis Premium via the Deakin library (refer to the Assignment Part – 2 instructions document). Download onto a spreadsheet for the last fifteen years (01/07/04 to 30/06/19) of dividend payments history for each of your three chosen companies.
2. All interim dividends must be appropriately annualized before adding up with the year-end final dividends in order to determine the true dollar value of yearly dividends received by the shareholders. For companies that have paid interim dividends, assume that those dividends were paid at the end of the first half of the year and therefore earn six months of interest at a risk-free rate for the next half. The current Australian Government's 10-year bond rate is 1.375% p.a.
3. After determining the dollar dividends received by shareholders for each of the past fifteen years, compute and justify a proxy annual constant growth rate of dividends to be used in Gordon’s model. Use your computed proxy annual constant growth rate to predict next year’s dollar dividend value.
4. Use Gordon’s model to solve for the expected return on equity for each of the stocks. Do these expected return figures appear justified given the nature the business,
5. the overall market conditions and the industrial sectors within which each of your chosen companies operates? Explain.
6. What do you feel are the most serious methodological problems associated with Gordon’s model? Outline your argument and carry out a review of relevant financial academic literature and identify at least two alternative costs of equity estimation methods(for example, CAPM and Fama- French three-factor model, etc.). Can these identified methods be better than Gordon’s model?

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