A Flexible Valuation Model Incorporating Declining Growth Rates

Abstract

A new model is developed in this paper which demonstrates a flexible method for modeling a cash flow stream with a declining growth rate that asymptotically approaches a mature long-term growth rate.  This model can be applied when the initial growth rate in cash flows is temporarily larger than the required rate of return.  A simple closed form equation of the valuation model is presented along with an example to illustrate the valuation of future cash flows with a declining growth rate.  A comparison is made with the valuation from multi-stage models that have constant growth segments, the H-Model, and the Ohlson-Juettner Model.  This highlights the difference in valuation that results from using this new model.  An example is also included to illustrate how to match a decline curve to a specific forecast of future cash flows.  This new declining growth model provides a flexible and practical approach for valuing equities.