I got this email from Mike Adhikari informing me about the Advanced Growth Model that he introduced as a better model compared to over-simplified capital structure assumption in the Gordon Growth Model.
Capitalization 2.0 will be released at the NACVA Conference on June 5th, 2019.
The current single-period capitalization method, and the method used to calculate the terminal value in the multi-period DCF are used when the business is growing at constant rate. These methods implicitly assume that, after the willing buyer buys the business, the capital structure of the business will remain constant, and that the debt principal will not be amortized (i.e. debt will never be repaid.)
Capitalization 2.0 eliminates these assumptions. It considers that even when the business is growing at a constant rate, the debt principal may have to be paid down, and hence the capital structure will change.
Current methods use Gordon Growth Model (GGM) formula, whereas Capitalization 2.0 uses the newly developed Advanced Growth Model (AGM) formula. Typically, GGM formula overvalues a business by 10-50%
Unlike the GGM formula, the AGM formula is complex; hence, a spreadsheet of AGM formula can be downloaded (free for a limited time) from the website www.AltBV.com.
Upon visiting his website, I got two papers that I could downloaded, as enclosed, and the summary of the differences in the results between Gordon Growth Model vs Advanced Growth Model, as follows:
I think this Advanced Growth Model concept is interesting as the capital structure assumption is on of the critical assumption in all valuation models. The issue, can we assume away, the capital structure to be constant, and no principal debt repayment in the long-term?
2 Articles by Mike Adhikari:
Article: Advanced Growth Model Reduces The Risk of Overvaluing From ‘Constant WACC’ Assumptions
Article : WACC as used in capitalization formula causes overvaluation