Abstract
This article discusses the conditions that justify the use of the constant growth model. The constant growth model is very sensitive to the assumptions regarding the firm's operating ratios, capital structure, and dividend policy. If the constant growth model is used and these factors are not coordinated and consistent, the valuation estimate using the equity method will not agree with the valuation estimate obtained with the invested capital method. On the other hand, if all the factors are coordinated, or “in sync,” these two methods will generate identical values when the constant growth model is used. Data presented at the end of the article suggests that only a small proportion of companies have growth rates that would make them good candidates to be valued using the constant growth model.
