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.19The 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:re=rf+β(rm−rf)= 0.0256 + 0.024 (0.0623-0.0256)=2.65%3.1.2Dividend Growth ModelThe 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.20The equation below gives a better understanding of the model:19Elson Goh, “Lecture 3: Cost of Capital and Valuation,” 2016, ?course_id=_75421_1&content_id=_3925956_1.16
P0=D1RE−gThe DGM is only applicable if some assumptions hold true. One assumption is that the companyshould 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:rE=D1P0+gThe variables in this equation has been obtained as follow:The share price at the beginning of the period, i.e. 1 July 2014 is $3.5.The dividend payment for the period was 0.12 as calculated in Appendix C with the values obtained from the Annual Report. This dividend payment assumes that the whole payment of dividend was made at the end of the period, i.e. 30 June 2015. However, the company paid dividend twice in the year that is on the 3rdOctober 2014 and on the 2ndApril 2015, less than one year after the recorded share price. The company does not pay dividend once a year and this is a limitation of the model.20“Dividend Growth Model,” Nasqad, accessed March 20, 2016, .17
The constant growth rate is obtained by multiplying expected return and retention ratio:g=(DividendEPS)X(Net IncomeTotal Equity)¿(0.120.13)x(11939000153949000)= 0.0716= 7.16%The Basic EPS is located in the Income Statement, the Net Income and the Total Equity are found in the Statement of Comprehensive Income and in Balance Sheet respectively.Using the above information, the cost of equity using the DGM is:rE=D1P0+g¿0.123.5+7.16= 10.59%3.1.3Evaluation and comparison of modelsThe return on equity using the CAPM gives a results of 2.65% while that obtained using DGM is10.59%. The difference when calculating the cost of equity using each model is relatively high with a result of 7.94%. This may due to the inaccuracy of the variables used to calculate the cost of equity in each case.