Question

Royal Bank Dividend Per share per Quarter. $$

2015: Q1 = 0.75 Q2 = 0.77 Q3 = 0.77 Q4 = 0.79

2016: Q1 = 0.79 Q2 = 0.81 Q3 = 0.81 Q4 = 0.83

2017: Q1 = 0.83 Q2 = 0.87 Q3 = 0.87 Q4 = 0.91

2018: Q1 = 0.91 Q2 = 0.94 Q3 = 0.94 Q4 = 0.98

2019: Q1 = 0.98 Q2 = 1.02 Q3 = 1.02 Q4 = 1.05

TD Bank Dividend Per share per Quarter. $$

2015: Q1 = 0.47 Q2 = 0.51 Q3 = 0.51 Q4 = 0.51

2016: Q1 = 0.51 Q2 = 0.55 Q3 = 0.55 Q4 = 0.55

2017: Q1 = 0.55 Q2 = 0.60 Q3 = 0.60 Q4 = 0.60

2018: Q1 = 0.60 Q2 = 0.67 Q3 = 0.67 Q4 = 0.67

2019: Q1 = 0.67 Q2 = 0.74 Q3 = 0.74 Q4 = 0.74

Other Information:

Recent Price of Stock: RY = $ 83.50 TD = $ 55.10

Annual Profit 2019: RY = $13 Billion TD = $11.7 Billion

Dividend Payout Ratio: RY = 46% TD = 43%

ROE: RY = 17.6% TD = 15.6%

2020 Annual Dividend Est.: RY = $ 4.20 TD = $ 3.11

Required:

A. The market expects this pattern of dividend increases to continue therefore, calculate the cost of equity for RY and TD. Show all work in detail.

B. If the both banks were not planning to raise external financing, then what will their respective growth rates be? Show all work in detail.

C. Identify some advantages and disadvantages of the Dividend growth model.

D. Given results above, would you recommend or not recommend either, both or neither as an investment instrument and why?

E. Given recent global events, what caveats or conditions might you add to your comments above?

Answer 1

Solution:

a)Calculation of cost of equity

Growth rate=[(Current dividend/Past dividend)^1/no. of years]-1

Growth rate for RY

=[(Annual dividend for Year 2019/annual dividend for Year 2015)^1/4]-1

=[($4.07/$3.08)^1/4]-1

=0.0722 or 7.22%

Growth rate for TD

=[($2.89/$2.0)^1/4]-1

=0.0964 or 9.64%

Cost of equity=(Estimated dividend/Share Price)+Growth rate

RY=($4.20/$83.50)+0.0722

=0.1225 or 12.25%

TD=($3.11/$55.10)+0.0964

=0.1528 or 15.28%

b)Calculation of growth rate

Growth rate=(1-Dividend payout ratio)*ROE

RY=(1-0.46)*17.6%

=9.504%

TD=(1-0.43)*15.6%

=8.892%

c)Advantages of dividend growth model:

i)It is very easy to understand and it is the most commonly used method to calculate share price.

ii)It is a very conservative model of valuation:Unlike other model that are sometimes used for stocks,the dividend valuation model does not require growth assumption to create a value.

Disadvantages of dividend growth model:

i)It only works on stocks which pay dividends:Most small businesses are not in a position to pay a dividend,which means this valuation model cannot be used to determine their value.

ii)It does not take into account non-dividend factors such as brand loyality,customer retention and ownership of intangibles assets.