The Zero Growth Model with Expected Inflation: Further Insights: A Consistent and Inflation Neutral Formulation for the Cost of Equity

12 Pages Posted: 1 Jun 2008

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: June 1, 2008

Abstract

The Constant Growth Model attributed to Gordon (the Gordon Model) is one of the most known and popular models in Corporate Finance. In this work we show that even with adjustments in the calculation of the proper Weighted Average Cost of Capital, WACC, in order to grant that the model with zero real growth and inflation is inflation neutral it has some inconsistencies. We develop a formulation for Ke, the cost of levered equity that is consistent and is inflation neutral. We identify problems of consistency and non inflation neutrality when using the Weighted Average Cost of Capital, WACC.

Keywords: Constant Growth Model, perpetuities, Terminal Value, cost of equity for perpetuities, tax savings

JEL Classification: G12, D61, G31, H43

Suggested Citation

Velez-Pareja, Ignacio, The Zero Growth Model with Expected Inflation: Further Insights: A Consistent and Inflation Neutral Formulation for the Cost of Equity (June 1, 2008). Available at SSRN: https://ssrn.com/abstract=1139666 or http://dx.doi.org/10.2139/ssrn.1139666

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

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