General question about valuing any sort of inflow with constant growth (dividends, FCF, RI)

When you have to value some sort of inflow with constant growth, we use the Gordon Growth Model. In the Gordon Growth model you grow the numerator by (1+g). Does this only apply to Dividends, FCFF, and FCFE?

I was doing the EOC questions for the Residual Income and came across number 14 about Dayton Manufactured Homes (pg. 519 Equity). This company has a growth rate of 10%. So when I came up with a residual value I did this calculation to arrive at the value of the residual income stream:


When the answer basically says to do this:


Is the reason we don’t grow RI is because it is RI and not like dividends and FCF?

Good question. I was wondering the same thing. I wouldn’t mind some rules on all of these. When do you include terminal for example.

Because we use a persistence factor with RI to determine its sustainability

The terminal value is included when we don’t know the exit value, and can be of multiple types (P/E with last EPS, P/B, H Model, DDM terminal, etc). It’s used once estimation is needed of the future growth rate from my experience. They will never give you 3 years of expected dividends and a terminal growth rate and expect the terminal growth value to be applied 1 year out, for example.

hmmm…still don’t get it but will think about it some more. So with RI we don’t grow it out one year because of this persistence factor?

Anyone else?

After doing some more EOC’s I think I’m just going to remember not to use the growth rate for residual income in the numerator when valuing the streams. Does that sound right to anyone?

I think the point here is that the RI they have calculated is the RI for the next period.

RI(1) = (ROE - r)x B(0)

So basically, if the model assumes one period of growth, then the growth has already been incorporated into the numerator. So P = B (0) + RI(1)/(r-g)

As someone mentioned earlier we use the persistence factor to replace growth.

The textbook does say that RI growth doesn’t make sense because it’s excess income you get AFTER required rate of return.

As I understand it RI should evenly shrink as time goes on. FCFF and dividends do not have these restrains.