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Estimation of the cost of equity capital using Gordon’s dividend discount model

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  1. Dividends of Australian listed companies from four different sectors
  2. Expected return on equity

Mishkin and Eakins, (2006) defines expected rate of return on equity as ?the amount of net income returned as a percentage of shareholders' equity.? The return on equity is used to estimate the profitability of a company by establishing the amount of income generated using investor funds. It is expressed as a percentage and calculated using the formula: (Return on Equity = Net Income/Shareholder's Equity).

[...] This method is based on the understanding that an investor is to be paid for both the time and the risk involved. Therefore it includes two components, a risk premium in addition to the rate for a security that is risk free. Basing on these factors, this model provides a more accurate expected return on equity. Any of the three methods above can be used to calculate the cost of equity. The values obtained by use of either of the method may vary owing to a number of factors. [...]


[...] USA. Pearson Prentice Hall. Watson, D. & Head, A. (2007), Corporate Finance: Principles and Practice, 4th ed, FT Prentice Hall, pp221?3. Watson, D. & Head, A. [...]


[...] Two other methods employed in calculating cost of equity are the capital Asset Pricing Model (CAPM) and the P/E Model. The price earning valuation model is recommended in stocks for companies whose dividend payout is inconsistent and that are growing at an irregular rate (Kumar and Hyodo, 2011). According to Easton (2003), Price Earnings ratio refers to the market price per share divided by the returns per that stock share. This method is best for comparison of two investments with one another. [...]


[...] & Lim, P. (2012) Analysts dividend forecast. Pacific Basin Finance Journal 10 21 Boritz, J. (2006). Maintaining Quality Capital Markets through Quality Information. Capital Markets Leadership Task Force Discussion Paper. Easton, P. (2003). PE Ratios, PEG Ratios, and Estimating the Implied Expected Rate of Return on Equity Capital. [...]


[...] This sector has high returns on investment owing to the booming real estate industry in Australia. With a booming economy and increased income for households, many people are starting to construct homes, those who are currently renting, or expand for those who already own houses. Increased demand for housing means increased income for construction companies. It also means the company will require more capital to finance its projects as most clients pay after completion of the work. In order to boost investor confidence, the company offers attractive dividends to its shareholders. [...]

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