Initial growth phase and Terminal value in the 3-stage dividend growth model

Analysts discuss the characteristics of firms in various stages of growth, where firms experience an initial growth phase, a transitonal phase, and a maturity phase in their life.

An analyst also makes the following statements.

1. For firms in the initial growth phase, earnings are rapidly increasing, there are little or no dividends, and there is heavy reinvestment. The return on equity is, however, higher than the required return on the stock, the free cash flows to equity are positive, and the profit margin is high.
2. When estimating the terminal value in the 3-stage dividend growth model, it can be estimated using the Gordon Growth Model or a price-multiple approach.

Are these statements correct?

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1. Answer: Incorrect.
• All of the description of the initial growth phase is correct except that, in this stage, the free cash flows to equity (FCFE) are actually negative.
• This is due to the heavy capital investment.
2. Answer: Correct.
• The terminal value in the three-stage dividend growth model can be estimated using either approach, i.e.
• Gordon Growth Model or
• price-multiple approach