Finance Question Paper

Time Allowed: 3 Hours

Allowed Word Count: 1000 words

Reference: Harvard Style

Data Source: Attached in ZIP Folder

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 the
Gordon’s model) can be inverted to derive the annual return expected by the equityholders of a certain
share. This is the methodology sometimes used to estimate the cost of equity capital for a firm.

1) You are required to apply Gordon’s model to estimate the cost of equity capital of a firm using
real data attached in ZIP Folder. 1) Choose three Australian listed companies (one each from
three different industry sectors) that have been in business for at least the last fifteen years.
Download onto a spreadsheet the last fifteen years (01/07/2007 to 30/06/2022) of dividend
payments history for each of your three chosen companies. Briefly describe the three companies
you have chosen. If possible, please avoid selecting companies with dividend payments
denominated in a foreign currency.
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 15-year bonds rate is 3.873%
p.a. (data accessed on 1st of July 2022)
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) Now look up the closing price of each of your three chosen stocks as on 30/06/2022. 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 current
market conditions, and the industrial sectors within which each of your chosen companies
operate? Explain.
5) 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 cost of equity estimation methods (for example, CAPM,
 FamaFrench three-factor model and Carhart four-factor model, etc.). Can these identified
methods be better than Gordon’s model? Argue your case. You must properly reference all
sources of information used and provide the name of the referencing style in the report.

(Total = 2 + 3 + 5 + 8 + 12 = 30 marks)