Pn2 = Value of equity at the end of transitional period
n1 = End of initial high-growth period
n2 = End of transition period
Sincethemodelassumesthatthegrowthrategoesthrough
threedistinctphases—highgrowth,transitionalgrowth,and
stablegrowth—itisimportantthatassumptionsaboutother
variables are consistent with these assumptions about growth.
- Itisreasonabletoassumethatasthefirmgoesfrom
high growth to stable growth, the relationship
between capital spending and depreciation will
change.Inthehigh-growthphase,capitalspendingis
likely to be much larger than depreciation. In the
transitionalphase,thedifferenceislikelytonarrow.
Finally,thedifferencebetweencapitalspendingand
depreciation will be lower still in stable growth,
reflecting the lower expected growth rate. - As thegrowth characteristicsof a firmchange, so
shouldits riskcharacteristics.Inthecontext ofthe
CAPM,asthegrowthratedeclines,thebetaofthe
firm can be expected to change. The tendency of
betastoconvergetoward 1 inthelongtermhasbeen
confirmedbyempiricalexaminationofportfoliosof
firms with high betas.
Sincethemodelallowsforthreestagesofgrowthandfora
gradual decline from high to stable growth, it is the
appropriatemodeltousetovaluefirmswithveryhighgrowth
ratescurrently.Theassumptionsaboutgrowtharesimilarto