Financial Performance Analysis of REA Group

This report provides a detailed analysis of the financial performance of REA Group, including capital structure and financial health. Techniques like Beta, Cost of Equity, Gearing Ratios, WACC, and more are used to analyze the company's financial health. The report also discusses the models of CAPM and DGM, along with the capital structure of the company. Ratios are calculated to provide a transparent view of the company's finances.

Running Head: REA GROUP 0
REA GROUP

REA GROUP 1
Executive Summary
Under this report the detailed analysis of the financial performance of the Rea Group with
regards to the capita; structure and the financial health of the company. To analyse the
financial health different techniques have been used such as Beta, Cost of Equity, Gearing
Ratios, WACC and lot more. The share price of the REA Group is $75.50 and the share price
movement of the Rea Group is less movable in comparison to the market. According to the
findings it was observed that the REA Group can be treated as the company which faces the
less risk and is readily giving the return on equity to the investors. In this report further the
models of the CAPM and the DGM have been discussed in detail and alongside the capital
structure of the company are also displayed. Further the ratios are also calculated to give a
transparent view of the finances of the company via equity and debt.
1

REA GROUP 2
Table of Contents
Executive Summary...................................................................................................................3
Introduction................................................................................................................................4
2. Weighted Average Cost of Capital (WACC).....................................................................4
2.1. Cost of Equity (COE)/ Return on Equity........................................................................5
2.1.1. CAPM..........................................................................................................................5
2.1.2. DGM............................................................................................................................8
3. Capital Structure of REA Group......................................................................................11
3.1. Debt to Value Ratio.......................................................................................................11
3.2 Equity to Value Ratio.....................................................................................................12
3.3 Debt to Equity Ratio......................................................................................................13
4. Analysis and Recommendation............................................................................................13
References................................................................................................................................15
6. Appendix I............................................................................................................................16
7. Appendix II..........................................................................................................................19
2

REA GROUP 3
Introduction
REA Group Limited and its subsidiary companies known as the REA Group which makes up
one of the most renowned flagship know for the global estate advertising company. The
headquarters of the REA Group is situated in Melbourne, Australia. The company is listed on
the Australian Stock Exchange and had A$807 million in the form of the revenue. The
company was founded in the year 1995 and furthermore, the company now operates in the
property websites among the 10 countries and it is being utilised by the 19000 agents. The
number of the visitors per month is approximately 8.8 million (REA GROUP, 2018). The
company also purchased the most demanded magazine Square foot in the year 2007, which is
also known as the first acquisition in Asia. Furthermore, the scenario changed for the
managers when the booking rental inspections were made easier as the company went into
the agreement with the Inspect Real estate. In this report, authors have gathered the financial
information regarding the REA Group from the website of the company, annual reports, the
other websites inclusive of Morningstar, Morning Star. After collecting the data from these
websites the authors have applied the technique of the CAPM, DGM, further using the cost of
equity the WACC has been calculated. Also the ratio analysis have been calculated and
necessary recommendations have also been provided to the company to make the necessary
changes where there are any variances and the negative impact on the performance of the
company (REA, 2018).
2. Weighted Average Cost of Capital (WACC)
Security holders are required to finance the assets and this can be done by applying the rate of
the weighted average cost of capital to pay on an average to all the holders of the assets. In
simpler words the shareholders are expecting the return on the investments made by them.
For the calculation of WACC there is a formula derived, and the formula is outlined below
(Frank & Shen, 2016).
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REA GROUP 4
WACC = Value of equity
value of the company ×Cost ofEquiry+ Value of Preference Shares
Value of the company ×Cost of Preference Shares+ V
Valu
2.1. Cost of Equity (COE)/ Return on Equity
The cost of equity is the required return that is the basic requirement of the company to figure
out whether the investment is meeting the capital return requirements. It is basically the
requirement of most of the companies and it is also used as a capital budgeting threshold rate.
The cost of equity is nothing but a demand from the market in the form of the compensation
against maintaining the assets and having the ability to bear the risk of the ownership. The
traditional formula to calculate the cost of the equity can be found below (Dhaliwal, Judd,
Serfling & Shaikh, 2016).
2.1.1. CAPM
Capital asset pricing model is the model designed to determine the theoretically rate of return
to make the decisions whether the investment shall be added in the portfolio or not.
In order to calculate CAPM, following formula can be used. The main purpose of this model
is to set a path for the asset’s sensitivity to the non-diversifiable risk can also be termed as the
market risk or the systematic risk. The risk is determined the Beta quantity along with the risk
free rate of return and the market rate of return (Barberis, Greenwood, Jin & Shleifer, 2015).
CAPM =Risk free return +( Market Risk Premium)
4
COST OF EQUITY= DIVIDENDS PER SHARE / CURRENT MARKET VALUE OF
STOCK + GROWTH ARTE OF DIVIDENDS

REA GROUP 5
To calculate the risk free rate of return the above formula is used by the company. Also the
rate that is used is specified by the Australian Government which is further used as the risk
free rate of return. In the review of the Reserve bank of Australia, the rate of return of the
government bond is 2.29% of January 2019. Market Risk Premium for Australia is 5.2%.
Apart from this the value of beta is also calculated and the relationship is also followed.
The data of the share price of REA Group and All ordinaries Price Index form Morning Star
for the purpose of the reflection of the percentage change in the data against the All Ords
Index price and the same has been reflected on the scatter pot. Tendency line has also been
presented in excel (REA, 2018).
-10% -8% -6% -4% -2% 0% 2% 4% 6% 8%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
Average return (REA Group)
Average return (REA
Group)
Linear (Average return
(REA Group))
Furthermore, regression analysis was done to derive the data in order to get the value of 
(Sensitivity of the relationship between derived data). The summary output has been
presented below.
SUMMARY
OUTPUT
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Regression Statistics
Multiple R
0.4599
51874
R Square
0.2115
55726
Adjusted R
Square
0.1876
63475
Standard
Error
0.0601
95245
Observations 35
ANOVA
df SS MS F
Signific
ance F
Regression 1
0.03208
4265
0.03
2084
8.85
4575
0.00543
6176
Residual 33
0.11957
443
0.00
3623
Total 34
0.15165
8695
Coeffic
ients
Standard
Error t Stat
P-
value
Lower
95%
Upper
95%
Lower
95.0%
Upper
95.0%
Intercept
0.0142
38365
0.01018
0197
1.39
8634
0.17
1251
-
0.00647
34
0.0349
50131
-
0.0064
734
0.0349
50131
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REA GROUP 7
X Variable 1
0.9445
22919
0.31741
5873
2.97
5664
0.00
5436
0.29873
5471
1.5903
10368
0.2987
35471
1.5903
10368
According to the summary of the regression output the final analysis is that the sensitivity
relationship accounts for 94.4%, i.e. the value of the  = 0.944522919. Furthermore, the
website of the Morning Star showcase the value of Beta is 1.21, whereas the beta value
according to the website of the Reuters of beta value is 1.31 (Reuters, 2018). Be that as it
may, the estimation of  will rely upon the timeframe taken in to calculations, for example,
week after week/month to month information (Austin & Steyerberg, 2015). In this way,
creators have futher determined  for the future estimations  = 0.944522919 (Chatterjee &
Hadi, 2015).
Based on the calculated figures, CAPM has been calculated as follows.
CAPM =0.029+0.523 (0.94)
= 0.522
2.1.2. DGM
Dividend Growth model, also known as the Gordon growth model, is the method of
calculating the intrinsic value of the stock which does not include the impact of the current
market conditions. The main feature of this model is the equalisation of the present value to
the stock’s future dividend (Zhang, Lü, Ran & Han, 2016).
Return on equity is also calculated using the assistance of the DGM Model taking the
dividends as the base which is extracted from the annual reports of the REA Group and also
from the website of the morning star. The dividends declared by the company from the year
2011 to 2017 are presented in the table below.
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REA GROUP 8
Yea
r
Dividend
Type
Cent Per
Share
Annual Dividend (Cents Per Share)
%
Change
2017
Final 51
Interim 40 91
2016
Final 45.5
Interim 36 81.5 11.66%
2015
Final 40.5
Interim 29.5 70 16.43%
2014
Final 35
Interim 22 57 22.81%
2013
Final 25.5
Interim 16 41.5 37.35%
2012
Final 20.5
Interim 12.5 33 25.76%
2011
Final 16
Interim 10 26 26.92%
Average Dividend Growth Rate 23.49%
From the above table it can be observed that the average dividend growth rate is 23.49%. The
current share price of the company is 75.50.
As per the table above Average dividend growth rate of the REA is 23.49% using the
calculated Average dividend growth next dividend was estimated using following formula.
Estimated Next Dividend 62.73
Declared Dividend 51
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REA GROUP 9
1+Dividend Growth rate 1.23
As per the above method, Cost of Equity was calculated as follows.
DGM = Estimated Next Divident
Currenct Share Price
DGM = 0.7916
75.50
= 0.0104
Note: Current share price of the REA Group is $ 75.50
As per the 2.1.1. and 2.1.2 above, COE has been calculated using both CAPM and DGM. In
order to get more accurate COE both values are average out to find out COE which will be
used for the future calculations of this paper (REA, 2018).
Cost of Equity= 0.522+ 0.0104
2
= 0.2662
Aside from the determined figures above, further information was extricated from the Annual
Report for the REA Group and website of the Morning Star
No of shares Issued 131715
Current Share Price ($) 75.50
Total Debt ($) 774083
Interest-bearing loans and borrowings($) 133828
Interest expense ($) 5692
Tax Rate in Australia 30%
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REA GROUP 10
Based on the above table, followings were calculated.
Cost of Debt= Interest expense
Interest −bearingloans∧borrowings
= 5692/133828
= 0.0425
Market value of the Equity ($) = No of shares outstanding x Share price
= 131715 x 75.50
= 9944482.5
Market Value of company ($) = Market Value of Equity + Total Debt
= 9944482.5 + 774083
= 10718565.5
Since the preference shares has not been issued by REA Group WACC calculated as follows.
WACC= Value of equity / value of the company × Cost of Equity+ Value of Preference Shares / Value of the
+ Value of Debt
Value of the company ×Cost of Debt × (1-Corporate Tax Rate )
WACC = 9944482.5
10718565.5 × 0.266+ 774083
10718565.5 ×0.0425 ×(1−0.3)
= 0.259
3. Capital Structure of REA Group
So as to break down the organization top to bottom following analysis was undertaken out.
3.1. Debt to Value Ratio
The debt to the value ratio is the ratio which comes under the category of the gearing ratio
and the same are calculated to determine how the company is being financed in comparison
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REA GROUP 11
to the total finances acquired by the company (Yu, Liu, Zhao & Liu, 2017). The ratio is also
helpful in determining the capacity of the company to pay back the debts with the assistance
of the value of the equity (Givoly, Hayn & Katz, 2017).
This ratio gives an understanding of how well the company is being financed by debt. The
relationship of the risk and the ratio is the direct relationship that suggests that lower the
ratio, the risk will be less from the perspective of the investor and the higher the risk, will
create less opportunities for the investment from the point of view of the investor. The overall
debt burden of the company shall be stable to support the company during the times of the
uncertainty.
Debt to value ratio of the company will be calculated by dividing total debt in possession of
REA Group by total value of debt and equity of the company.
Debt 774083
Total Value 1071856
6
Debt to Value
Ratio
0.07221
9
3.2 Equity to Value Ratio
Equity is an important part of the organisation as it reveals the portion of the funds
outsourced by the company. This is what the ratio talks about, equity to value ratio can be
determined by dividing the value of the equity by the total value of the debt and the equity to
understand the measure of the proportion of the equity the company is dealing with. This
ratio is mainly ruled by the investments made by the investors (Lewis & Tan, 2016).
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REA GROUP 12
Equity to value ratio of the REA Group will be calculated by dividing total equity from total
value of the company as follows.
Equity 9944484
Total Value 1071856
6
Equity to Value
Ratio
0.92778
1
3.3 Debt to Equity Ratio
This ratio is the combination of the above two ratios and displays the overall risk the
company is possessing. If the ratio is high it indicates that the finances made by the company
are more form the use of the credit facilities such as bank loans rather than utilising the
equity. The total value is segregated between the investors and the creditors and the same is
represented with the help of analysing this ratio (Abel, 2018).
Debt to Equity ratio will be calculated by dividing total debt by total equity of REA Group.
Debt 774083
Equity 994448
3
Debt to Equity
Ratio
0.07784
All the calculated figures can be summarized as follows.
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REA GROUP 13
Beta Equity % Debt % Debt to
Equity
Cost of
Equity
Cost of
Debt
WACC
REA 0.944 92.7% 7.22% 7.7% 26.62% 4.25% 25.9%
Industry 0.93
4. Analysis and Recommendation
After making all the calculations according to their respective formulas there are following
recommendations which shall be kept in mind. REA GROUP’s equity is more than the debt it
has financed, and also further it can be seen that the debt to equity ratio of the company is
0.077 which indicates that the company trusts the investments made by the investors and the
shareholders. The cost of equity is higher than the cost of debt which is a reversal of the
above situation as it reflects that lots of funds are being paid by the company to the
shareholders rather than the creditors. Therefore the company owns the high amount of risk
for it hence there shall be a change in the capital structure of the REA group and the company
shall opt for the debt finance more, or at least up to 30% to reduce the cost borne by the
company, this will also give the tax advantage to the company (Bekaert & Harvey, 2017).
Furthermore, the analysis of the Beta value suggest that if the Beta is more than 1 it is high
and confines to higher risk. From the calculation point of view the Beta value of the Rea
Group is 0.944 and the investors of the company are going to bear the less risk in comparison
to the other companies. Also the price movement of the company can reflect that the changes
are less fluctuating in terms of the market and hence the company is at the lower risk.
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REA GROUP 14
References
Abel, A. B. (2018). Optimal Debt and Profitability in the Trade‐Off Theory. The Journal of
Finance, 73(1), 95-143.
Ai, H., Bansal, R., Im, J., & Ying, C. (2018). A Model of the Macroeconomic Announcement
Premium with Production. Available at SSRN 3286693.
Austin, P. C., & Steyerberg, E. W. (2015). The number of subjects per variable required in
linear regression analyses. Journal of clinical epidemiology, 68(6), 627-636.
Barberis, N., Greenwood, R., Jin, L., & Shleifer, A. (2015). X-CAPM: An extrapolative
capital asset pricing model. Journal of financial economics, 115(1), 1-24.
Bekaert, G., & Harvey, C. (2017). Emerging equity markets in a globalizing world.
Brusov, P., Filatova, T., Orekhova, N., & Eskindarov, M. (2018). New meaningful effects in
modern capital structure theory. In Modern Corporate Finance, Investments, Taxation and
Ratings (pp. 537-568). Springer, Cham.
Chatterjee, S., & Hadi, A. S. (2015). Regression analysis by example. John Wiley & Sons.
Dhaliwal, D., Judd, J. S., Serfling, M., & Shaikh, S. (2016). Customer concentration risk and
the cost of equity capital. Journal of Accounting and Economics, 61(1), 23-48.
Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of
capital. Journal of Financial Economics, 119(2), 300-315.
Givoly, D., Hayn, C., & Katz, S. (2017). The changing relevance of accounting information
to debt holders over time. Review of Accounting Studies, 22(1), 64-108.
Hoepner, A., Oikonomou, I., Scholtens, B., & Schröder, M. (2016). The effects of corporate
and country sustainability characteristics on the cost of debt: An international
investigation. Journal of Business Finance & Accounting, 43(1-2), 158-190.
Lewis, C. M., & Tan, Y. (2016). Debt-equity choices, R&D investment and market
timing. Journal of Financial Economics, 119(3), 599-610.
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REA GROUP 15
Lorenz, D., Kruschwitz, L., & Löffler, A. (2016). Are costs of capital necessarily constant
over time and across states of nature?: Some remarks on the debate on ‘WACC is not quite
right’. The Quarterly Review of Economics and Finance, 60, 81-85.
REA GROUP, (2018). REA Group Ltd. REA. Retrieved from
https://www.morningstar.com.au/Stocks/NewsAndQuotes/REA
REA, (2018). Annual Reports. Retrieved from https://www.rea-group.com/company/investor-
centre/annual-reports/
REA, (2018). REA Group Ltd (REA.AX). Retrieved from
https://www.reuters.com/finance/stocks/overview/REA.AX
Yu, Z., Liu, K., Zhao, C., & Liu, Y. (2017, April). Combined Forecasting Model of Traffic
Flow Based on DGM (1, 1) and GRNN. In Computing Intelligence and Information System
(CIIS), 2017 International Conference on (pp. 58-61). IEEE.
Zhang, J., Lü, X., Ran, M., & Han, G. (2016). DGM model based on anti-cotangent function
and its application. Journal of Grey System, 28(3), 63.
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REA GROUP 16
6. Appendix I
Market Index and Share Prices of REA Group
Rea Group S&P 200
Date Adj Close Average return (REA
Group)
Date Adj
Close
Average
return
(S&P)
1/1/2015
46.7610
7 1/1/2015
2/1/2015
46.2514
6 -1% 2/1/2015 5928.8
3/1/2015
45.5625
5 -1% 3/1/2015 5891.5 -1%
4/1/2015 44.8409 -2% 4/1/2015 5790 -2%
5/1/2015
37.0936
6 -17% 5/1/2015 5777.2 0%
6/1/2015
37.2265
8 0% 6/1/2015 5459 -6%
7/1/2015
41.2141
2 11% 7/1/2015 5699.2 4%
8/1/2015
39.2203
5 -5% 8/1/2015 5207 -9%
9/1/2015
42.4946
1 8% 9/1/2015 5021.6 -4%
10/1/2015 46.0518 8% 10/1/2015 5239.4 4%
11/1/2015
48.1324
3 5% 11/1/2015 5166.5 -1%
12/1/2015
52.8210
3 10% 12/1/2015 5295.9 3%
1/1/2016
50.6253
4 -4% 1/1/2016 5005.5 -5%
2/1/2016
49.8103
6 -2% 2/1/2016 4880.9 -2%
3/1/2016
51.8046
8 4% 3/1/2016 5082.8 4%
4/1/2016 49.1611 -5% 4/1/2016 5252.2 3%
5/1/2016
54.0559
8 10% 5/1/2016 5378.6 2%
6/1/2016
57.4350
7 6% 6/1/2016 5233.4 -3%
7/1/2016
63.0154
2 10% 7/1/2016 5562.3 6%
8/1/2016
56.5854
8 -10% 8/1/2016 5433 -2%
9/1/2016
54.9225
7 -3% 9/1/2016 5435.9 0%
10/1/2016 49.7562 -9% 10/1/2016 5317.7 -2%
16

REA GROUP 17
5
11/1/2016
50.2232
6 1% 11/1/2016 5440.5 2%
12/1/2016
53.7355
8 7% 12/1/2016 5665.8 4%
1/1/2017
51.1378
3 -5% 1/1/2017 5620.9 -1%
2/1/2017 55.0004 8% 2/1/2017 5712.2 2%
3/1/2017
57.7246
4 5% 3/1/2017 5864.9 3%
4/1/2017 60.2499 4% 4/1/2017 5924.1 1%
5/1/2017
62.8758
4 4% 5/1/2017 5724.6 -3%
6/1/2017
65.0608
8 3% 6/1/2017 5721.5 0%
7/1/2017
67.6280
3 4% 7/1/2017 5720.6 0%
8/1/2017
64.9628
9 -4% 8/1/2017 5714.5 0%
9/1/2017
66.1487
1 2% 9/1/2017 5681.6 -1%
10/1/2017
71.3616
3 8% 10/1/2017 5909 4%
11/1/2017
77.7889
1 9% 11/1/2017 5969.9 1%
12/1/2017 75.6761 -3% 12/1/2017 6065.1 2%
1/1/2018
72.7142
1 -4% 1/1/2018 6037.7 0%
Source: ASX Historical data and Morningstar
7. Appendix II
Movement of Ten Year Government Bond Rates
Source: Reserve Bank of Australia
17