Return to Fundamentals: Perpetuities, Common Wisdom and the Use of the Gordon Constant Growth Model
10 Pages Posted: 23 Jun 2008 Last revised: 22 Sep 2008
Date Written: June 28, 2008
In this work we explain the proper use of perpetuities and the value of them. We consider two cases: calculating the value on period zero when the perpetuity starts with a given cash flow in period 1 and when it starts from a cash flow in period zero and it grows in period 1 at a given rate (as when we calculate a terminal or continuing value). We derive the proper expressions for the two cases.
In particular we focus the analysis when there is no real growth and expected inflation is positive.
We conclude that depending on which is the case we can use or not the Constant Growth Model (Gordon Model).
Keywords: WACC, CGM, Constant Growth Model, Gordon Model, perpetuities, terminal value, tax savings
JEL Classification: D61, G31, H43
Suggested Citation: Suggested Citation