When Can the Constant Growth Model Be Used?

by Maestri

The constant growth model is often appropriate for mature companies with a stable history of growth. Expected growth rates vary somewhat among companies, but dividend growth for most mature firms is generally expected to continue in the future at about the same rate as nominal gross domestic product (real GDP plus inflation). On this basis, one might expect the dividends of an average, or “normal,” company to
grow at a rate of 5 to 8 percent a year.

Note too that Equation 5-2 is sufficiently general to handle the case of a zero growth stock, where the dividend is expected to remain constant over time. If g 0, Equation 5-2 reduces to Equation 5-3:
This is essentially the same equation as the one we developed in Chapter 2 for a perpetuity, and it is simply the dividend divided by the discount rate.

Taken From : Five-Minute MBA – Corporate Finance

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