Constant Growth FCFE Model
TheconstantgrowthFCFEmodelisdesignedtovaluefirms
thataregrowingatastablerateandarehenceinsteadystate.
Thevalueofequity,under theconstantgrowthmodel,isa
functionoftheexpectedFCFEinthenextperiod,thestable
growth rate, and the required rate of return.
where
P 0 = Value of equity today
FCFE 1 = Expected FCFE next year
ke= Cost of equity of the firm
gn= Growth rate in FCFE for the firm forever
ThemodelisverysimilartotheGordongrowthmodelinits
underlyingassumptionsandworks undersomeofthesame
constraints.Thegrowthrateusedinthemodelhastobeless
than or equal to the expected nominal growth rate in the
economyinwhichthefirmoperates.Theassumptionthata
firm isin steadystate also implies thatit possesses other
characteristicssharedbystablefirms.Thiswouldmean,for
instance, that capital expenditures, relative to depreciation,
arenot disproportionately largeand thefirmis ofaverage
risk.(Ifthecapitalassetpricingmodelisused,thebetaofthe
equityshouldnotsignificantlydifferfrom1.)Toestimatethe
reinvestmentforastablegrowthfirm,youcanuseoneoftwo
approaches.