I was really confused on question 2 because it’s my understanding that the H-model is used when the short term growth rate declines into the long term growth rate linearly.
In the problem text they state that the company has “a growth rate of 20% per year over the next four years (2014 through 2017) and a 6% constant growth rate beyond 2017”
That doesn’t sound like a linear decline, it sounds like +20% each year leading into 2017.
The problem treats it like it declines. How did you read it?
Agreed. I really didnt like that set of questions. I didnt agree with their answer for #1 either.
yes, its poorly worded… got me too
Goin off memory, but the way I read the question, is given a set of assumptions, you can still apply the H-model to value it. It’s like putting a square peg into a round hole, but just because 1 person has an assumption that the growth rate is going to be 20%, 20%, 20%, then 6%, it doesn’t mean you as an analyst can’t decide to use the H-model and see what the valuation would be IF it declines lineraly. (which is what the question is asking you to do… model it as IF it is declining linearly).
This leads into Question 4, of the same problem set which then goes along the line of… hey, the data we have doesn’t seem to fit what we expect to see with the H-model. “A smoother transition” to the mature phase would be better… So, your intiution is right, and is then tested in a follow-up question.
Hope that helps.,
Yes agreed. Growth rate should be decreased to long term rate linearly over the period