wheregn= Growth rate after terminal year forever
Thesamecaveatsthatapplytothegrowthrateforthestable
growthratemodel,describedintheprevioussection,apply
hereaswell.Inaddition,theassumptionsmadetoderivethe
freecashflow toequityafter theterminalyearhavetobe
consistent with the assumption of stability. For instance,
whilecapitalspendingmaybemuchgreaterthandepreciation
intheinitialhigh-growthphase,thedifferenceshouldnarrow
asthefirmentersitsstable-growthphase.Wecanusethetwo
approachesdescribedforthestable-growthmodel—industry
averagecapitalexpenditurerequirementsorthefundamental
growth equation (equity reinvestment rate = g/ROE)—to
makethisestimate.Thebetaanddebtratiomayalsoneedto
be adjusted in stable growth to reflect the fact that
stable-growthfirmstendtohaveaveragerisk(betascloserto
- and use more debt than high-growth firms.
Thismodelmakesthesameassumptionsaboutgrowthasthe
two-stagedividenddiscountmodel—thatis,thatgrowthwill
behighandconstantintheinitialperiodanddropabruptlyto
stablegrowthafterthat.Itisdifferentbecauseofitsemphasis
on FCFE rather than dividends. Consequently, it provides
muchbetterresultsthanthedividenddiscountmodelwhen
valuingfirmsthateitherhavedividendsthatareunsustainable
(becausetheyarehigherthanFCFE)orpaylessindividends
than they can afford to (i.e., dividends are less than FCFE).
ILLUSTRATION 5.8: Two-Stage FCFE Model: Toyota
ToyotaMotorCorporation isoneofthelargest automobile
companies in the world. In 2005, it was also the most
profitablewithitsnewhybridscapturingmarketsharefrom