In2004,Blockbuster,thevideorentalcompany,reportedan
after-taxreturnoncapitalof4.06%andareinvestmentrateof
26.46%. If it maintains these numbers in perpetuity, its
expected growth rate can be estimated as follows:
Assumethatthefirmwillseeitsreturnoncapitalincreaseon
bothitsexistingassetsanditsnewinvestmentsto6.20%next
yearandthatitsreinvestmentratewillstayat26.46%.The
expected growth rate next year can be estimated.
If theimprovement in return on capital on existing assets
occursmoregraduallyoverthenextfiveyears,theexpected
annualgrowthrateforthenextfiveyearscanbeestimatedas
follows:
Thefirsttermintheequationrepresentsexpectedgrowthin
earningsfrom newinvestmentsand thesecondcapturesthe
additionalgrowth eachyearfrom any existingassets more
efficiently.
Negative Return on Capital Scenario
Thethirdandmostdifficultscenarioforestimatinggrowthis
whena firmislosing moneyand hasa negativereturnon
capital.Sincethefirmislosingmoney,thereinvestmentrate
willalsobenegative.Toestimategrowthinthesefirms,we