Question

Assume that the Vana Inc. Corporation’s expected earnings per share (E₁) are $12, its dividend payout ratio is 70%, and its return on equity (ROE) is 20%. The investors’ required rate of return (k) on the stock is 10% per year. What is the company’s present value of growth opportunity (PVGO)? ******PLEASE SHOW WORK

Answer 1

Sustainable growth rate = ROE * (1 - Dividend Payout Ratio)

Sustainable growth rate = 20% * (1 - 70%) = 6%

Based on the question, expected earnings = $12 per share

Hence, expected dividend = $12 per share * 70% = $8.4 per share

Now, we need to apply the dividend discount model to calculate the PVGO.

First, let us assume there is no growth in the dividends expected in future. This implies,

Present Value of Share (without growth in dividends) = Dividend Expected/Required rate of Return = $8.4/10% = $84

Now, present value of share (with growth in dividends) = Dividend Expected/(Required rate of Return - Growth Rate) = $8.4/(10% - 6%) = $210

PVGO = $210 - $84 = $126