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.
a)Choose four Australian listed companies (one each from four different sectors) that have been in business for at least the last ten years. Access Morningstar Datanalysis Premium via the Deakin library (refer to the Assignment Part – 2 instructions document). Download onto a spreadsheet the last ten years of dividend payments history for each of your four chosen companies.
a) 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 10-year bonds rate is 2.88% p.a.
b) After determining the dollar dividends received by shareholders for each of the past ten 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.
c) Finance and look up the closing price of each of your four chosen stocks 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 of the business, the overall market conditions and the industrial sectors within which each of your chosen companies operate?
d) What do you feel are the most serious methodological problems associated with Gordon’s model? Carry out a review of relevant financial academic literature and identify at least two alternative cost of equity estimation methods. Can these identified methods be better than Gordon’s model? Argue your case.