what happens if in a gordon valuation the growth is greater than the cost of equity? I get a negative valuation. what do I
Stacey Warren - Expert brainly.com
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You could try to forecast more yearly cash flows, and then discount them using your cost of equity. I guess you could also ask yourself this question: is my projected growth a valid estimate? The object that you are valuating cannot have a rather high growth factor for ever. Sooner og later it will decline. Remember: as your denominator moves toward zero, the present value at time t gows toward infinity
In normal terms the growth you are projecting should not be higher than the risk-free rate what means that it cannot exceed the cost of equity. Otherwise the company in the long term will be likely to be bigger than the economy as a whole.... So, as Hoel suggested think of extending the high growth period before pushing down the growth rate toward the risk-free rate during the stable period.
thanks a lot :)
So to sum up, I need to average out the growth I think the company will have from now to infinity?
or should I divide the gordon formula into 2 periods somehow?
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Yes, I would "average out" the growth that I think the company will have, by extending the budgeted cash flows. Therefore, you should perhaps do a "three-stage growth"-model analysis. See "Equity Asset Valuation" by Pinto et al. 2010, page 192. I'm guessing Professor Damodaran also have something on the subject.