Constant growth rate vs sustainable growth rate

Tural · November 4, 2018, 2:09am

While doing practice questions I noticed questions where it says the sustainable growth rate, however in calculations there is no need to use Do(1+g)/(r-g). So, the question is, why in some cases we use D o /r to get the value and on other instances, we use D o**(1+g)/(r-g)**. Is the point in the difference between " sustainable growth rate" versus " constant growth rate" ?

Thanks

S2000magician · November 4, 2018, 5:40am

The sustainable growth rate satisfies:

g = ROE × b

The constant (Gordon) growth model is:

P₀ = D₀ (1 + g) / (r − g) = D₁ / (r − g)

This is valid whether g is the sustainable growth rate or not. If g = 0, then,

P₀ = D₀ (1 + g) / (r − g) = D₀ (1 + 0) / (r − 0) = D₀ / r = D₁ / r