Investment Analysis and Recommendation Paper
Dividend Growth Model
The dividend growth model helps in the in-depth understanding of equity by forecasting
business performance and selecting the appropriate valuation model. Return on investment is a
method that determines the efficiency of a company by dividing the returns and the cost of the
investment (Isiklar, 2005). Just as its name suggests, retention ratio refers to the percentage of
the net income that remains to grow the business after dividends have been paid. The price of
stock is the cost at which an investor needs to undergo in purchasing securities in the exchange
market. Earnings per share are the portion that indicates the company’s profitability as it
indicates the monetary value of earnings per outstanding share of the company’s stocks.
The financial information used in these calculations was drawn from the income
statement shown in Appendix A. Appendix B shows the dividend in stock for Chesapeake
Energy Corporation of the year 2014. After calculating the net income of the company of 2014,
the income is found to be $586,000 with an equity of 3. The total dividend of the company was
$207.80 in the year 2014 with an outstanding share of $665.14. The total earnings of the
company were $0.1952 in total. The dividends per shares that were offered by the company in
DIVIDEND GROWTH MODEL 2
2014 were $2.32%, which is a good return to the company shareholders. The price of the
company’s stock in 2014 was recorded as $15.06, which is also good news for the company
shareholders. The calculations of the stock prices in relation to the ROE and retention ratio are
shown in Appendix C. The following are formulas that have been used in the analysis that was
carried out below:
The Rate of Return (ROE) = Net income/ Equity
Retention ratio = 1 – (cash dividends/ net income)
Growth rate in earnings (g) = Retention ratio x ROE
Dividend Discount Model (DDM) = Return rate (R)
= Dividend/ (Price of Stock) +g
Price of Stock = Dividend/ (Return Rate (R)-Growth Rate (g))
Issues with Using the Growth Model
Growth model by Chesapeake Energy Corporation brings issues as it relies much of the
company growth rate model that assumes stable growth (Coe, 2002). This model demands that
the Chesapeake Energy Corporation company stock is hypersensitive to the entire growth
dividend rate that is provided that cannot exceed the cost of equity. The growth model brings
along the issue of not taking into account non dividend factors that are inclusive of brand loyalty
and customer retention in Chesapeake Energy Corporation.
Growth
The Reasonability of Constant Growth is tested through the use of discounted cash flow
DIVIDEND GROWTH MODEL 3
that resides in the very heart of any valuation that the company is geared to use in its operations
(Gomes, 2010). The use of reasonability of constant growth ensures that understanding about any
given value of the most important perception is given in the right way ever for the benefit of the
company success. Therefore, it is necessary to assume a constant growth in the company.
Conclusion
The numbers arrived at using dividend growth model seen logical and feasible as can be
evidenced in the appendix. However, the use of dividend growth model seems complex and
cumbersome due to several calculations and steps involved. It is reasonable to assume a constant
growth in a company provided all the necessary requirements are taken into consideration.
DIVIDEND GROWTH MODEL 4
The Bullock Gold Mining Assignment
The estimates provided by Danto can be used by Alma to determine the revenue that is
expected from the gold mine. The expense of opening the mine and the annual operating
expenses is determined. Opening the mine will cost an initial capital of $750 million with a cash
outflow of $75 million for 9 years. The expected cash flows from the mine for the 9 year period
is represented by the table shown below.
Table 1. Summary Table
Year Cash flow $ (million)
0 -$750
1 130
2 180
3 190
4 245
5 205
DIVIDEND GROWTH MODEL 5
6 155
7 135
8 95
9 -75
Discussion
Payback Period
The payback period is the time taken by the investment to recoup the initial cash injected
into the project. Lucrative projects have shorter payback period than the non-lucrative project
that tends to have a long payback period. The calculation of the payback period of this case is
summarized in the appendix E.
Net Present Value
The Net Present Value (NPV) involves the calculations of the percentage return rate, less
the initial cash outlay. The NPV bigger than 1, implies that the project is lucrative and
economically viable and is worth the risk (Griffin, 2009). On the other hand, the NPV value
which is less than one implies that the investment is less lucrative since the returns will be less
than the costs involved in the project (Cornett, Adair, & Nofsinger, 2013). In this case, the
calculations of NPV are shown in appendix F.
DIVIDEND GROWTH MODEL 6
Internal Rate of Returns (IRR)
In this case, a rate of 12% provides an IRR of $1,594,792,833. Since it can be discounted
on both the higher and the lower rate, the project IRR higher than the discounting rate of returns
is acceptable as shown in the Appendix G.
Modified Internal Rate of Return
The modified IRR operates on the principle that the positive cash flows are reinvented at
the firm’s cost of capital and the firms’ financial cost are done with the initial capital outlay
(Bragg, 2009). In this regard, the modified IRR stands out as the most precise way of
determining the cost and profitability of an investment as can be seen in the appendix H (Cullen,
& Broadbent, 2012).
Conclusion
The Bullock Gold Mining case can be analyzed by the use of Payback Period, NPV, IRR,
and modified IRR. From the calculations in the appendix, all the above calculations show
positive results to imply that the project is worth investing in. Therefore, the Ballock Gold mine
is a viable project.
DIVIDEND GROWTH MODEL 7
References
Bragg, S. (2009). Accounting Control Best Practices. Wiley
Cheasapeake Corp. (2015). Company Profile: Chesapeake Energy Corporation. MarketLine
Coe, P. J. (2002). Power issues when testing the markov switching model with the sup likelihood
ratio test using U.S. output. Empirical Economics, 27(2), 395-401 Financial Service
Professionals. Journal of Financial Service Professionals. 74-82.
Cornett, M., Adair, T., & Nofsinger, J. (2013). M:Finance.McGraw-Hill/Irwin; 2 edition
Cullen, J., & Broadbent, M. (2012). Managing Financial Resources (CMI Diploma in
Management Series). Routledge; 3 edition
Gomes, O. (2010). Consumer confidence, endogenous growth and endogenous cycles. Journal of
Economic Studies, 37(4), 377-404
Griffin, M. (2009). MBA Fundamentals Accounting and Finance. Kaplan Publishing
DIVIDEND GROWTH MODEL 8
Isiklar, G. (2005). Essays on macroeconomic forecasting (Order No. 3177045). Available from
ABI/INFORM Complete. (305363178)
Appendix A
Income Statement for Chesapeake Energy Corporation (CHK)
DIVIDEND GROWTH MODEL 9
Appendix B
Chesapeake Energy
Corporation
Year 2014
Net income $ 586,000
Equity $ 3
Total dividends paid $ 207.80
Outstanding shares $ 665.14M
Earnings per share (EPS) $ 0.1952
Dividends paid per share $ 2.32%
Stock price as of _ Chesapeake
Energy Corporation (CHK)
$ 15.06
DIVIDEND GROWTH MODEL 10
Appendix C
Analysis Formula Year 2014
ROE Net income/ Equity $ 195333.3
Retention ratio 1 – (cash dividends/ net
income)
$ 0.9996
Growth rate in earnings (g) Retention ratio x ROE $ 195255.17
Appendix D
Dividend Discount Model (DDM) =
(2.32%/ 15.06) +195255.17
= 195255.32
2.32% / (195255.32-195255.17)
= $ 15.47
Appendix E
Payback Period represents the number of years before the project pays off
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Year 0= -750
Year 1=-750 130= -620
Year 2=-750 130 180= – 440
Year 3= -750 130 180 190= -250
Year 4= -750 130 180 190 245= -5
Year 4= -750 130 180 190 245 205= 200
This gold mine project will pay off between the 4 th and the 5 th year
5/205= 0.0244
Appendix F and 12% rate
Initial investment ($750,000,000)
1st year’s return $130,000,000
2nd year’s return $180,000,000
3rd year’s return $190,000,000
4th year’s return $245,000,000
5th year’s return $205,000,000
6th year’s return $155,000,000
7th year’s return $135,000,000
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8th year’s return $95,000,000
$1,594,792,883
Appendix G
IRR can be calculated as follows
Description Data Data
initial investment ($750,000,000) ($750,000,000)
1st years returns $130,000,000 $130,000,000
2nd years returns $180,000,000 $180,000,000
3rd year returns $190,000,000 $190,000,000
4th year returns $245,000,000 $245,000,000
5th year returns $205,000,000 $205,000,000
6th year returns $155,000,000 $155,000,000
7th year returns $135,000,000 $135,000,000
8th year returns $95,000,000 $95,000,000
16% 14%
Appendix H
Modified IRR can be calculated as follows
DIVIDEND GROWTH MODEL 13
Description data
MIRR after 3
year
initial investment ($750,000,000) 220%
1st years returns $130,000,000
MIRR After 7
years
2nd years returns $180,000,000 613%
3rd year returns $190,000,000
4th year returns $245,000,000
5th year returns $205,000,000
6th year returns $155,000,000
7th year returns $135,000,000
8th year returns $95,000,000
