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Lesson 8 of 9 · 12 min
Shortcomings of constant and multistage growth models
Growth-based DCF models can mislead because the chosen cash flow may miss part of the value, the base year and static assumptions may not represent the future, the going-concern assumption can fail, and the cost of capital moves with the economy.
In short
- Bottom-up problems: the cash flow measure may be incomplete, the base year unrepresentative, and the assumptions static while the company changes.
- Dividends miss buybacks; DPS growth applied to total dividends ignores changes in payout and share count.
- FCFE depends on an assumed debt ratio; FCFE and FCFF both need hard-to-define margins and investment.
- Transformational growth, startups and inflection points break the model; sudden distress is better handled with probability-weighted scenarios.
- Top-down problems: risk-free rates change WACC and ; match the rate's term to the horizon and use long-run averages. Use several models.
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