Growth in Perpetuity for Shareholder Value Method

This variation of the Perpetuity Method assumes that the cash flows grow (or decay) at a compound rate of g forever. This method, usually referred to as the Gordon Model, is characterized by the K - g term in the denominator and next year's cash flow in the numerator.

The main limitation to this approach is that it may not fully recognize the cash outflows for additional investments that are likely to be required for continued growth. Also, it ignores capital structure: the growing cash flows can often lead to severe changes in capital structure (e.g., high debt/equity ratios) that are undesirable or economically unrealistic. Finally, the method makes no assumption about the economic return on the investment required for the growth. Thus, the net present value of the growth in perpetuity can yield a value less than, equal to or greater than that of the Perpetuity Method (where the economic assumption of growth yielding NPV = 0 is invoked).

Note:

As perpetuity growth rates approach the long-term cost of capital, the residual value rises toward infinity - because the denominator in the formula below goes toward zero - which is clearly not a reasonable assumption.