Lesson 6 of 11 · All lessons in this module
- Present value models: DDM and FCFEVideo lesson
- Choosing the cash flow: dividends or FCFE
- FCFF, EBITDA and residual income
- Preferred stock and the Gordon growth modelVideo lesson
- Multistage dividend discount modelsVideo lesson
- Growth assumptions for any cash flow: constant, implied and two-stage
- The DCF process: discount rates, terminal values and ranges
- Integrated cases: negative growth and reconciling FCFE with FCFF
- Integrated cases: two-stage FCFF with debt, and the effect of the debt ratio
- Shortcomings of constant and multistage growth models
- Preferred shares: required return and contingency features
This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 6 of 11 · 15 min
Growth assumptions for any cash flow: constant, implied and two-stage
The constant and two-stage growth models work for FCFE and FCFF as well as dividends; the market price can be turned into an implied growth rate, and growth itself is estimated from history (watch the base year) or from the sustainable growth rate.
In short
- General constant growth model: , with r matched to the cash flow. It suits mature, stable firms.
- An FCFE value of total cash flows is the equity value: divide by shares; do not subtract debt.
- g must be below r and, long term, should not exceed nominal economic growth. Firms in decline can have negative g.
- Implied growth: : the steady growth the price assumes.
- Historical growth rates suffer from the base effect: a spike or trough in the starting year biases the rate.
- SGR = (1 − payout) × ROE; with FCFE use 1 − FCFE/NI; with FCFF use (1 − FCFF/NOPAT) × return on capital.
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