Part 1: The Connection Between Growth, Returns, and Value
Suppose you’re looking at a company that has NO competitive advantage, and is therefore unable to generate a return above its cost of equity.
Imagine that this company has the following characteristics:
Return On Equity = 8%
Cost Of Equity = 8%
Shareholder’s Equity = $100m
Cash = $0
Value the equity in this company using the following assumptions:
A) Value with sustainable growth rate = 0%:
B) Value with sustainable growth rate = 4%:
C) Can this company create value for its investors by reinvesting its cash flows? Explain why, or why not.