Aswath Damodaran 525
Disney: Inputs to Valuation
High Growth Phase Transition Phase Stable Growth Phase
Length of Period 5 years 5 years Forever after 10 years
Tax Rate 37. 3 % 37. 3 % 37. 3 %
Return on Capital 12 % (last year’s return o n
capital was 4. 42 %)
Declines linearly to 10 % Stable ROC of 10 %
Reinvestment Rate
(Net Cap Ex + Working Capital
Investments/EBIT)
53. 18 % (Last year’s
reinvestment rate)
Declines to 40 % as ROC and
growth rates drop:
Reinvestment Rate = g/ROC
40 % of after-tax operating
income, estimated from stable
growth rate of 4 % and return
on capital of 10 %.
Reinvestment rate = 4 / 10 = 40 %
Expected Growth Rate in EBIT ROC * Reinvestment Rate =
12 %* 0. 5318 = 6. 38 %
Linear decline t o Stable
Growth Rate of 4 %
4 %: Set to riskfree rate
Debt/Capital Ratio 21 % (Existing debt ratio) Increases linearly to 30 % Stable debt ratio of 30 %
Risk Parameters Beta = 1. 25 , ke = 10 %
Cost of Debt = 5. 25 %
Cost of capital = 8. 59 %
Beta decreases linearly to 1. 00 ;
Cost of debt stays at 5. 25 %
Cost of capital drops to 7. 16 %
Beta = 1. 00 ; ke = 8. 82 %
Cost of debt stays at 5. 25 %
Cost of capital = 7. 16 %
The transition period is used as a phase where the inputs from the high growth
period can be adjusted towards stable growth levels (which reflect industry or
market averages).
Note that we estimate reinvestment needs using the expected growth rate and the
return on capital.
We are making the assumption that Disney will continue to earn excess returns
even in stable growth. (The return on capital is moved towards the cost of
capital, but it is still higher than the cost of capital). If that assumption seems
over optimistic, the return on capital in stable growth can be set equal to the cost
of capital.
The leverage is pushed up to 30%, which was the constrained optimal we arrived
at in the capital structure section.
