Expected Growth in EBIT =.5(18.69%) = 9.35%
n
The forecasted reinvestment rate is much higher than the actual
reinvestment rate in 1996, because it includes projected acquisition.
Between 1992 and 1996, adding in the Capital Cities acquisition to all
capital expenditures would have yielded a reinvestment rate of roughly
50%.

Aswath Damodaran
35
The No Net Cap Ex Assumption
n
Many analysts assume that capital expenditures offset depreciation,
when doing valuation. Is it an appropriate assumption to make for a
high growth firm?
o
Yes
o
No
n
If the net cap ex is zero and there are no working capital requirements,
what should the expected growth rate be?

Aswath Damodaran
36
Return on Capital, Profit Margin and Asset
Turnover
n
Return on Capital
= EBIT (1-t) / Total Assets
= [EBIT (1-t) / Sales] * [Sales/Total Assets]
= After-tax Operating Margin * Asset Turnover
n
Thus, a firm can improve its return on capital in one of two ways:
•
It can increase its after-tax operating margin
•
It can improve its asset turnover, by selling more of the same asset base
n
This is a useful way of thinking about
•
choosing between a low-price, high-volume strategy and a high-price,
lower-volume strategy
•
the decision of whether to change price levels (decrease or increase) and
the resulting effect on volume

Aswath Damodaran
37
Firm Characteristics as Growth Changes
Variable
High Growth Firms tend to
Stable Growth Firms tend to
Risk
be above-average risk
be average risk
Dividend Payout
pay little or no dividends
pay high dividends
Net Cap Ex
have high net cap ex
have low net cap ex
Return on Capital
earn high ROC (excess return)
earn ROC closer to WACC
Leverage
have little or no debt
higher leverage

Aswath Damodaran
38
Estimating Stable Growth Inputs
n
Start with the fundamentals:
•
Profitability measures such as return on equity and capital, in stable
growth, can be estimated by looking at
–
industry averages for these measure, in which case we assume that this firm in
stable growth will look like the average firm in the industry
–
cost of equity and capital, in which case we assume that the firm will stop
earning excess returns on its projects as a result of competition.
•
Leverage is a tougher call. While industry averages can be used here as
well, it depends upon how entrenched current management is and whether
they are stubborn about their policy on leverage (If they are, use current
leverage; if they are not; use industry averages)
n
Use the relationship between growth and fundamentals to estimate
payout and net capital expenditures.

Aswath Damodaran
39
Estimate Stable Period Payout
g
EPS
= Retained Earnings
t-1
/ NI
t-1
* ROE
= Retention Ratio * ROE
= b * ROE
n
Moving terms around,
Retention Ratio = g
EPS
/ ROE
Payout Ratio = 1 - Retention Ratio = 1 - g
EPS
/ ROE

Aswath Damodaran
40
Estimating Stable Period Net Cap Ex
g
EBIT
= (Net Capital Expenditures + Change in WC)/EBIT(1-t) * ROC
= Reinvestment Rate * ROC
n
Moving terms around,
Reinvestment Rate = g
EBIT
/ Return on Capital
n
For instance, assume that Disney in stable growth will grow 5% and
that its return on capital in stable growth will be 16%. The

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- Corporate Finance, Net Present Value, Generally Accepted Accounting Principles, Aswath Damodaran