Factors That Affect the Growth Rate of Equity Capital

Six factors that affect either the transient or the long-term growth rate of equity capital are identified. The use of the net present value method of financial accounting to compute the equity value of hypothetical firms is described. Simulation of sequences of capital budgeting decisions in hypothetical firms was used to illustrate the effects of the six factors on the growth rate of equity capital. The upper limit of a firm's steady-state capital growth rate was affected by (1) the maximum yield attainable from its long-term investments, (2) its debt policy, (3) its budget allocation policy, and (4) the (average) life of its long-term investments. Unless the selection procedure was random, the transient values of a firm's annual growth rate of equity were affected appreciably by (1) the growth rate of its long-term investment opportunities, (2) its debt policies, and (3) its past decisions. Random variation in the growth rate of investment opportunities had little affect on the average growth rate of the firm, but it had appreciable affect on the year to year values. The factors that had the greatest influence on the long-term growth of equity capital were generation of high yielding investment opportunities and estimating expected values of cash flows accurately.