Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

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to reinvestat thespecified returnoncapital. Growthfrom
existingassetscanoccuronlyintheshortterm,sincethereis
a limit to how efficiently you can utilize existing assets.


3.Lengthoftheextraordinarygrowthperiod.Giventhatwe
cannot estimate cash flows forever, we generally impose
closure in valuation models by assuming that cash flows,
beyondtheterminalyear,willgrowataconstantrateforever,
whichallowsustoestimatetheterminalvalue.Thus,inevery
discounted cash flow valuation, there are two critical
assumptions we need to make on stable growth. Thefirst
relatestowhenthefirmthatwearevaluingwillbecomea
stable-growthfirm,ifitisnotonealready.Theanswertothis
question will depend in large part on the magnitude and
sustainabilityofthecompetitiveadvantagespossessedbythe
firm.Thesecondrelatestowhatthecharacteristicsofthefirm
willbeinstablegrowth,intermsofreturnoncapitalandcost
of capital. Stable-growth firms generally have small or
negligible excess returns and are of average risk.



  1. Cost of capital. The expected cash flows need to be
    discountedbackata ratethatreflectsthecostoffinancing
    theseassets.RecappingthediscussioninChapter2,thecost
    ofcapitalis acomposite costof financingthatreflects the
    costsofbothdebtandequity,andtheirrelativeweightsinthe
    financingstructure.Thecostofequityrepresentstherateof
    returnrequiredbyequityinvestorsinthefirm,andthecostof
    debtmeasuresthecurrentcostofborrowing,adjustedforthe
    taxbenefits ofborrowing.A firm’scost of capitalwillbe
    determinedbythemixofdebtandequityitchoosestouse,
    andwhetherthedebtreflectstheassetsofthefirm;long-term
    assetsshouldbefundedwithlong-termdebtand short-term
    assetsbyshort-termdebt.Usingasuboptimalmixofdebtand

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