 Financial Terms Constant-growth model

# Definition of Constant-growth model ## Constant-growth model

Also called the Gordon-Shapiro model, an application of the dividend discount
model which assumes (1) a fixed growth rate for future dividends and (2) a single discount rate.

# Related Terms:

## constant-growth dividend discount model

Version of the dividend discount model in which dividends grow at a constant rate.

## Arbitrage-free option-pricing models

Yield curve option-pricing models.

## Asset pricing model

A model for determining the required rate of return on an asset.

## Asset pricing model

A model, such as the Capital Asset Pricing model (CAPM), that determines the required
rate of return on a particular asset.

## Binomial model

A method of pricing options or other equity derivatives in
which the probability over time of each possible price follows a binomial
distribution. The basic assumption is that prices can move to only two values
(one higher and one lower) over any short time period.

## Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

## Black-Scholes model

The first complete mathematical model for pricing
options, developed by Fischer Black and Myron Scholes. It examines market
price, strike price, volatility, time to expiration, and interest rates. It is limited
to only certain kinds of options. ## Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

## Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security

## Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

## capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

## Constant dollar accounting

A method for restating financial statements by reducing or
increasing reported revenues and expenses by changes in the consumer price index,
thereby achieving greater comparability between accounting periods.

## Constant dollars

See real dollars.

## Critical Growth Periods

Times in a company's history when growth is essential and without which survival of the business might be in jeopardy.

## Deterministic models

Liability-matching models that assume that the liability payments and the asset cash
flows are known with certainty. Related: Compare stochastic models

## Discounted dividend model (DDM)

A formula to estimate the intrinsic value of a firm by figuring the
present value of all expected future dividends. ## dividend discount model

Computation of today’s stock price which states that share value equals the present value of all expected future dividends.

## Dividend discount model (DDM)

A model for valuing the common stock of a company, based on the
present value of the expected cash flows.

## dividend growth method

a method of computing the cost
of common stock equity that indicates the rate of return
that common shareholders expect to earn in the form of
dividends on a company’s common stock

## Dividend growth model

A model wherein dividends are assumed to be at a constant rate in perpetuity.

## economic components model

Abrams’ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

## Extrapolative statistical models

models that apply a formula to historical data and project results for a
future period. Such models include the simple linear trend model, the simple exponential model, and the
simple autoregressive model.

## Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

## Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

## Gordon model

present value of a perpetuity with growth.
The end-ofyear Gordon model formula is: 1/(r - g)
and the midyear formula is: SQRT(1 + r)/(r - g).

## growth funds

Mutual funds that seek long-term capital growth. This type of fund invests primarily in equity securities.

## Growth manager

A money manager who seeks to buy stocks that are typically selling at relatively high P/E
ratios due to high earnings growth, with the expectation of continued high or higher earnings growth. ## Growth opportunity

Opportunity to invest in profitable projects.

## Growth phase

A phase of development in which a company experiences rapid earnings growth as it produces
new products and expands market share.

## growth rate

an estimate of the increase expected in dividends
(or in market value) per share of stock

## Growth rates

Compound annual growth rate for the number of full fiscal years shown. If there is a negative
or zero value for the first or last year, the growth is NM (not meaningful).

## Growth stock

Common stock of a company that has an opportunity to invest money and earn more than the
opportunity cost of capital.

## Index model

A model of stock returns using a market index such as the S&P 500 to represent common or
systematic risk factors.

## Internal growth rate

Maximum rate a firm can expand without outside source of funding. growth generated
by cash flows retained by company.

## internal growth rate

Maximum rate of growth without external financing.

a model that involves
(1) few physical assets,
(2) little management hierarchy, and
(3) a direct pipeline to customers

## log size model

Abrams’ model to calculate discount rates as a function of the logarithm of the value of the firm.

## Market model

This relationship is sometimes called the single-index model. The market model says that the
return on a security depends on the return on the market portfolio and the extent of the security's
responsiveness as measured, by beta. In addition, the return will also depend on conditions that are unique to
the firm. Graphically, the market model can be depicted as a line fitted to a plot of asset returns against
returns on the market portfolio.

## Markowitz model

A model for selecting an optimum investment portfolio,
devised by H. M. Markowitz. It uses a discrete-time, continuous-outcome
approach for modeling investment problems, often called the mean-variance

## Modeling

The process of creating a depiction of reality, such as a graph, picture, or mathematical
representation.

## Net present value of growth opportunities

A model valuing a firm in which net present value of new
investment opportunities is explicitly examined.

## percentage of sales models

Planning model in which sales forecasts are the driving variables and most other variables are
proportional to sales.

## Pie model of capital structure

A model of the debt/equity ratio of the firms, graphically depicted in slices of
a pie that represent the value of the firm in the capital markets.

## Present value of growth opportunities (NPV)

Net present value of investments the firm is expected to make
in the future.

## present value of growth opportunities (PVGO)

Net present value of a firm’s future investments.

## QMDM (quantitative marketability discount model)

model for calculating DLOM for minority interests r the discount rate

## Simple compound growth method

A method of calculating the growth rate by relating the terminal value to
the initial value and assuming a constant percentage annual rate of growth between these two values.

## Simple linear trend model

An extrapolative statistical model that asserts that earnings have a base level and
grow at a constant amount each period.

## Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

## Single index model

A model of stock returns that decomposes influences on returns into a systematic factor,
as measured by the return on the broad market index, and firm specific factors.

## Single-index model

Related: market model

## Stochastic models

Liability-matching models that assume that the liability payments and the asset cash flows
are uncertain. Related: Deterministic models.

## Sustainable growth rate

Maximum rate of growth a firm can sustain without increasing financial leverage.

## sustainable growth rate

Steady rate at which a firm can grow without changing leverage; plowback ratio × return on equity.

## Two-factor model

Black's zero-beta version of the capital asset pricing model.

## Two-state option pricing model

An option pricing model in which the underlying asset can take on only two
possible (discrete) values in the next time period for each value it can take on in the preceding time period.
Also called the binomial option pricing model.

## Value-at-Risk model (VAR)

Procedure for estimating the probability of portfolio losses exceeding some
specified proportion based on a statistical analysis of historical market price trends, correlations, and volatilities.

## Yield curve option-pricing models

models that can incorporate different volatility assumptions along the
yield curve, such as the Black-Derman-Toy model. Also called arbitrage-free option-pricing models.

## fractional interest discount

the combined discounts for lack of control and marketability. g the constant growth rate in cash flows or net income used in the ADF, Gordon model, or present value factor.