Substituting in thestable growth rate asa function of the
reinvestment rate, from above, we get:
Settingthereturnoncapitalequaltothecostofcapital,we
arrive at:
Simplifying, the terminal value can be stated as:
Wecouldestablishthesamepropositionwithequityincome
andcashflowsandshowthatareturnonequityequaltothe
costofequityinstablegrowthnullifiesthepositiveeffectof
growth.
ILLUSTRATION 4.13: Stable Growth Rates and Excess
Returns
Alloy Mills is a textile firm that is currently reporting
after-taxoperatingincome of$100million.Thefirmhasa
returnoncapitalcurrentlyof20%,acostofcapitalof10%
andreinvests50%ofitsearningsbackintothefirm,givingit
an expected growth rate of 10% for the next five years: