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The zero growth model with expected inflation: further insights. A consistent and inflation neutral formulation for the cost of equity

Author

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  • Ignacio Velez-Pareja

Abstract

The Constant Growth Model attributed to Gordon (the Gordon Model) is one of the most known and popular models in Corporate Finance. In this work we show that even withadjustments in the calculation of the proper Weighted Average Cost of Capital, WACC, in order to grant that the model with zero real growth and inflation is inflation neutral it hassome inconsistencies. We develop a formulation for Ke, the cost of levered equity that is consistent and is inflation neutral. We identify problems of consistency and non inflation neutrality when using the Weighted Average Cost of Capital, WACC.

Suggested Citation

  • Ignacio Velez-Pareja, 2008. "The zero growth model with expected inflation: further insights. A consistent and inflation neutral formulation for the cost of equity," Proyecciones Financieras y Valoración 4708, Master Consultores.
    • Handle: RePEc:col:000463:004708
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    File URL: http://papers.ssrn.com/abstract=1139666
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    More about this item

    Keywords

    Constant growth model; perpetuities; terminal value; cost of equity for perpetuities; tax savings;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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