Growth vs. Discount Rate relationship

CFA Level II
#1

Hello,

I was reading in the text that the growth rate and discount rate on cash flow are inversely proportional to each other.

However, if you think about it if the growth is higher on cash flows related to a stock, wouldn’t if have to be discounted by a higher rate if we were to keep the price of the stock constant?

My guess is that I do not understand this relationship intuitively.

Thanks,

#2

In which book, chapter, and page did you see that?

#3

Just looking at the gordon growth perpetuity model, you can see the “r-g” in the denominator of the equation. This “r-g” relationship implies that discount and growth would be invserely related to each other.

Not sure if its worth chasing this down for the exam though.

Thanks,

#4

Have you read this conclusion from the book itself or is yours? I ask because r-g in the Gordon formula does not imply the discount rate and the growth rate are inversely related. In fact, you need first to clear “g” and “r” correctly and then conclude. If you derive properly the Gordon growth model formula:

P = D0 x (1+r) / (r - g)

You will arrive at:

g = [r x (P - D0) - D0] / P

As you see, “g” and “r” are directly related (positively related). So the question in your original post was right:

For life of course it matters! For the exam it is not that important tho, but this thinking is good for understanding the formula. Many people nowadays apply formulas, use complicated software, etc but are completely unaware of how those things work and what exactly do. They don’t even know how to interpret those formulas and software results properly !!