100%(2)2 out of 2 people found this document helpful
This preview shows page 12 - 15 out of 26 pages.
may hold in practice if the investors are well-diversified. In Section 1: Shareholder Analysis, it has been found that the shareholders are well-diversified and therefore this assumption does hold. However, this assumption may also be invalid since the not all shareholders have a diversified portfolio. The variables of the equation have been established as follow: The risk-free rate chosen is the 10-year Australian government bond. This specific bond has been chosen since it is considered to be the safest bond on the market. The current government rate as quoted by Bloomberg is 2.56%.19CAPM relies on historical values than actual value, and therefore the government bond given by Bloomberg is considered to be equal to the historical bond rate for the given period for this report. The 10-year Australian government bond is considered to be risk-free but in real world situation this is not the case.2017ZviBodie et al., Principles of Investments(McGraw-Hill Education (Australia) Pty Ltd, 2013), 72. 18Ben McClure, “The Capital Asset Pricing Model: An Overview,” Investopedia, accessed March 20, 2016, . 19“Australian Rates & Bonds,” Bloomberg Market, accessed March 20, 2016, . 20Elson Goh, “Lecture 3: Cost of Capital and Valuation,” 2016, 3925956_1.
12 The beta for the given time period has been calculated in Appendix E. The beta obtained through regression analysis of the discrete weekly return for the stock against the discrete weekly return for All Ordinaries index is 0.024. It is assumed that the beta will remain constant throughout the period analysed. The market’s return which was sourced in Section 2.2 is quoted as 6.23%.The return on equity calculated using CAPM is therefore given by: ࠵?L= ࠵?M+ ࠵?(࠵?J− ࠵?M)= 0.0256 + 0.024 (0.0623-0.0256) =2.65% 3.1.2Dividend Growth Model The dividend growth model (DGM) assumes that the dividends grow perpetually at a constant rate. The price of the stock is equal to the ratio of the next year dividend to the difference between the rate of return of equity and the constant growth rate.21The equation below gives a better understanding of the model: ࠵?P=࠵?Q࠵?R− ࠵?The DGM is only applicable if some assumptions hold true. One assumption is that the company should pay dividend at a constant growth rate. Royal Wolf Holdings has been paying semi-annual earnings per share. The return on equity using the Dividend Growth Model would be given by: ࠵?R=࠵?Q࠵?P+ ࠵?The variables in this equation has been obtained as follow: 21“Dividend Growth Model,” Nasqad, accessed March 20, 2016, .
13 The share price at the beginning of the period, i.e. 1 July 2014 is $3.5.