risklessratethatgoesintothediscountrateandthegrowth
rateoftheeconomy.Notethattherisklessratecanbewritten
as:
Inthelongterm,therealrisklessratewillconvergeonthe
realgrowthrateoftheeconomy,andthenominalrisklessrate
willapproach thenominal growthrateof theeconomy. In
fact,asimpleruleofthumbonthestablegrowthrateisthatit
should not exceed the riskless rate used in the valuation.
Key Assumptions about Stable Growth
Ineverydiscountedcashflowvaluation,therearetwocritical
assumptions youneedto make onstable growth.Thefirst
relatestowhatthecharacteristicsofthefirmwillbeinstable
growth,intermsofreturnoninvestmentsandcostsofequity
andcapital.Thesecondassumptionrelates tohowthefirm
that you are valuing will make the transition from high
growth to stable growth.
Characteristics of Stable-Growth Firm
Asfirmsmovefromhighgrowthtostablegrowth,youneed
togivethemthecharacteristicsofstable-growthfirms.Afirm
in stable growth is different from that same firm in high
growthon anumberofdimensions.In general,you would
expect stable-growthfirmsto beless risky,usemoredebt,
havelower (orzero) excessreturns, and reinvestless than
high-growthfirms.Inthissubsection,weconsiderhowbest
to adjust each of these variables.