Part I: Checking the Perpetuity Growth Rate

Equity Valuation in R

Cliff Ang

Senior Vice President, Compass Lexecon

Checking the Perpetuity Growth Rate

Perpetuity Growth Rate (PGR) is a sustainable growth rate

  • It cannot be greater than the overall growth rate of the economy
  • It is a growth rate that is financed by the operations of the firm
Equity Valuation in R

Determinants of the Perpetuity Growth Rate

The PGR is bounded by the following relationship:

            PGR = Reinvestment Rate * Return on Equity,

where

  • Reinvestment Rate = (CapEx + Incr. in WC - D&A) / After-Tax Income

  • Return on Equity equals the Cost of Equity in steady-state

Equity Valuation in R

Example

Suppose you have a firm with a reinvestment rate of 20% and an ROE of 10%. Can the firm sustain an assumed PGR of 4%?

reinvestment <- 0.20
roe <- 0.10

reinvestment * roe

0.02

pgr <- 0.04
pgr / roe

0.4
Equity Valuation in R

Let's practice!

Equity Valuation in R

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