out of curiousity, what if you have expected growth rate that is too high for a stable firm…and how would you intepret the valuation of that particular stock if g > r ? valuation turns out to be negative…if m not wrong…
The value should be infinite.
Don’t worry; ain’t gonna happen on the exam.
…on the exam… expect a curveball. not g > r but some other twisted mess to untangle.
acutally saw this come up last night in the Schweser Q bank, correct answer was something along the lines of “does not compute”
Here’s the Question where i got stucked, option c confused me…what i thought…the way the statement “c” is framed sounds me that g>r…but in the question they’ve implicity assumed that g
In the stable-growth FCFE model, an extremely low value can result from all of the following EXCEPT:
A) capital expenditures are too high relative to depreciation.
B) the required rate of return is too high for a stable firm.
C) the expected growth rate is too high for a stable firm.
Assuming that g that you reference is the common definition of g (i.e., perpetual growth rate), g cannot exceed r (other than in the imagination of an incompetent analyst).
obviously for 2 stage model a high g is ok in first stage.
going back to the question, you will get a low value if r is too high ( large denominator) or if there is little free cash flow ( capital expenses > depn), so that leaves C.
dont worry what C) means, just that the result will be garbage (chipotle mexican grill…)