Dividend Valuation Model Case Sudy - Ashtead Group

A. Report: Ashtead Group plc

Estimation of the cost of equity capital of Ashtead Group plc

Dividend valuation model

The dividend valuation model as it was stated by Myron Gordon in 1963 requires three inputs: the current dividend per share, the current ex-div. share price and the dividend growth rate. There are problems with all three inputs.

Ashtead’s shares for the year ended 30 April 2017 went ex-div. on 17/8/2017 and its share price was 1,580 p. However, we are trying to calculate the current cost of equity and, at the time of writing, (April 5th 2018), the current share price is 1,974.50p. Calculating Ashtead’s cost of equity using different share prices will provide different results.

Another problem concerns the expected future rate of dividend growth. This is normally forecasted on the basis of the past dividend growth rate. Different time periods will produce different results.

For the purpose of this report we will calculate the dividend growth rate for the past 15 years using the total annual dividends, (interim + final) and the first year will be the year ended 30/4/2003 with total dividend paid 0.62p and for the year ended 30/4/2017 27.50p. This is a 5-year period, therefore n = 5. Using the formula we calculate:

g = [(27.50 / 0.62) ^ (1/15) -1] = 28.76%

However, at the time of writing the company has also paid its interim dividend for the year ending 30/4/2018 (5.50p) and so it could be argued that the latest annual dividend is the final of 2017 plus the interim of 2018.

There is no single right answer to any of the aforementioned implications.

If we use the current (5/4/2018) share price of 1,974.50p, the 15-year average growth rate of 28.76% and the total dividend paid for the year ended 30/4/2017 of 27.50p, the cost of equity capital can be calculated as follows:

Ke = ([27.50 x (1 + 0.2876)] / 1,974.50) + 0.2876 = 30.56%

An important assumption of the dividend valuation model is that future dividend growth will remain constant at 28.76%

A final emphasis should be drawn upon the time value of money which is imputed in the above calculations.

Capital asset pricing model (CAPM)

The CAPM requires three items of input data: the risk free rate of return (RF), the market risk premium (RM-RF) and the company’s equity beta (be). There are several implications in determining the values of all three elements.

Usually, the return of government bonds is considered the most appropriate risk free rate of return. However, the government bonds do not always come without any risk, but they are considered to be the least risky investments and hence the best input for the risk free rate.

In the European Union the least risky bonds are those of Germany (bunds), but for the purpose of this report, we will use the 10-year average yield on UK government bonds on the basis that Ashtead is a UK company and therefore the UK bonds are more acceptable, particularly in terms of default risk. Using longer-term bonds (more than 10 years) would create further implications as it would contain inflation risk.