Abstract
Purpose The traditional one-stage constant growth formula has two main underlying assumptions: a company will be able to maintain its competitive advantage for completed investments in perpetuity, and each year in the future, it will be able to generate new investment opportunities with the same competitive advantage, which will also remain in perpetuity. The purpose of this paper is to develop a model that limits the duration of the competitive advantage. Design/methodology/approach A new model is developed, and it is used to value a public company. Findings In this study, the author introduces an alternative formula considering the duration of the competitive advantage, imposing a restriction on the fact that extraordinary returns cannot be sustained forever, and also separates the part of the value explained by the current investments from the portion of value created by future investments. Originality/value The traditional one-stage constant growth model used to determine the continuing value of a company has limitations regarding the duration of the competitive advantage. The developed formula corrects the problem limiting the time extraordinary returns will remain over time.
Highlights
The creation of value by a company depends fundamentally on its ability to generate, in a sustained manner over time, a return on capital invested in excess of its cost of capital
We develop an alternative formula for the traditional one-stage constant growth model, in which we incorporate restrictions to consider the loss of competitive advantage to limit the period in which extraordinary returns will exist
The competitive advantage of a company is reflected in the extraordinary returns over the cost of capital
Summary
The creation of value by a company depends fundamentally on its ability to generate, in a sustained manner over time, a return on capital invested in excess of its cost of capital. We develop an alternative formula for the traditional one-stage constant growth model, in which we incorporate restrictions to consider the loss of competitive advantage to limit the period in which extraordinary returns will exist. This restriction will prevent overestimation of the returns in the long term. The main contribution of this paper is the introduction of a more flexible alternative model to the one-stage constant growth model, where the value of the company is separated into three parts: invested capital, the value created from the invested capital and value created from growth This allows the introduction of special conditions to each of the parts that form the value of the company, limiting the competitive advantage over time. The traditional one-stage constant growth model The present value of cash flow with a constant cost of capital is expressed as follows: PV 0
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