The Terminal Value and Inflation Controversy

Journal of Applied Corporate Finance (2012), 24(3), p. 101-107

Posted: 4 Oct 2012

See all articles by Daniel Kiechle

Daniel Kiechle

University of Hohenheim

Niklas Lampenius

University of Hohenheim - Faculty of Business, Economics and Social Sciences

Multiple version iconThere are 2 versions of this paper

Date Written: October 2, 2012

Abstract

This journal recently published a debate between professors Gunther Friedl and Bernhard Schwetzler (hereafter “F&S”), on the one hand, and professors Michael Bradley and Gregg Jarrell (“B&J”), on the other hand. B&J initiated the first round of the debate by criticizing the constant growth valuation model, commonly known as the ”Constant Growth Model” or “Gordon Growth Model”, which was introduced by Myron Gordon and Eli Shapiro (“G&S”) in a 1956 paper and has long been widely used by corporate and investment practitioners. F&S replied to B&J with a defense of the original G&S formulation. In revisiting this debate, we find that the models B&J and F&S advocate are simply two versions of the G&S constant growth model, but with different assumptions about the amount of capital reinvestment required to sustain businesses indefinitely. By using a consistent set of assumptions about inflation and capital reinvestment, we resolve the dispute by showing that both models produce identical growth rates and estimates of value. At the same time, however, we recognize that both models (the G&S/F&S model and the B&J model) are appropriate for only a small subset of companies. The typical firm most likely operates somewhere between the two extremes.

Keywords: Terminal Value, Constant Growth Model, Valuation, Inflation

Suggested Citation

Kiechle, Daniel and Lampenius, Niklas, The Terminal Value and Inflation Controversy (October 2, 2012). Journal of Applied Corporate Finance (2012), 24(3), p. 101-107, Available at SSRN: https://ssrn.com/abstract=2155632

Daniel Kiechle

University of Hohenheim ( email )

Fruwirthstr. 48
Stuttgart, 70599
Germany

Niklas Lampenius (Contact Author)

University of Hohenheim - Faculty of Business, Economics and Social Sciences ( email )

Stuttgart, 70593
Germany

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