It’s interesting that the valuation of an organization could be influenced by a simple analysis of growth rates despite the organization possibly experiencing rapid growth in the initial stage and a prolonged stable growth in the future…
The table below precisely demonstrates this. For example, if we assume that the growth rate in the first 5 years of the forecast period is 25% annually, while after 5 years it stabilizes and becomes only 3%, the average compounded growth would be 7.3%.
Why does this matter?
The forecasted parameter of the growth rate has a significant impact on the final valuation, so it should be as objective as possible. With the given comparison, it is also possible to consider the estimation of growth rate terms of other organizations operating in the industry or comparable organizations’ expected growth rates:
g = r – FCF[1] / V[0]
This formula can be applied to two-stage analysis, using WACCs for discounting evaluations, taking into account the cost of capital and performing a comparative analysis of comparable organizations’ growth rate terms with the assumptions of market equilibrium…
P.S.
Sometimes the market indicates an increase rather than a decrease in growth rates…
Source:
Corporate Valuation Theory, Evidence and Practice
Mark E. Zmijewski; Robert W. Holthausen
Second Edition