In carrying out valuation what do we do when the calculated growth rate is greater the required rate of return.
Use something other than the Gordon Growth Model: the growth rate of the dividends in perpetuity cannot exceed the required rate of return.
(Similarly, the growth rate of dividends in perpetuity cannot exceed the growth rate of the economy.)
Many thanks sir, I still have following questions. 1. How accurate is using the yield on 10yr federal government bond as the required rate of return ? 2. In using CAMP model to calculate the required rate of return of a non-US economy, how do I determine the expected market return? Also how reliable is the beta of stock given on FT.COM Thanks for your anticipated response.
Not very: you’re using a risk-free rate as a proxy for a (potentially very) risky investment. At the very least, you’ll need to add a risk premium to your risk-free rate.
There are probably as many methods in practice as there are analysts in practice. A simple method would be to look at the average market return over a suitable historical period. Better might be to run a regression on historical market returns and extrapolate that to the future. Better still would be to examine economic fundamentals over an historical period, do a (multiple) regression of the market’s return compared to those fundamentals, project those fundamentals into the future, and compute the market return from the (extrapolated) regression model.
(Disclaimer: I’ve never done any of this in practice; perhaps someone else here has and can let you know the approach they use.)
I don’t know firsthand, but it’s probably reliable given the historical data they choose to use. Whether that will be representative of beta in the future is anybody’s guess.
My pleasure, though I may not have helped much.
I thought I’ll replace the g with the growth rate of the economy