Parcel Corporation is expected to pay a dividend of $5 per share next year, and the dividends pay out ratio is 50%. If the dividends are expected to grow at a constant rate of 8% forever and the required rate of return on the stock is 13%, calculate the present value of the growth opportunity.
A) $100
B) $76.92
C) $23.08
D) None of the above

Question

Quizplus · Accepted Answer

The present value of growth opportunities (PVGO) can be calculated using the formula: PVGO = P0 - (E1 / r), where P0 is the price of the stock with growth, E1 is the earnings per share next year, and r is the required rate of return. First, calculate the price of the stock with growth using the Gordon Growth Model: P0 = D1 / (r - g) = $5 / (0.13 - 0.08) = $100. The earnings per share (E1) is $10 (since the payout ratio is 50%, the dividend is half of the earnings). Therefore, PVGO = $100 - ($10 / 0.13) = $100 - $76.92 = $23.08.

Parcel Corporation Is Expected to Pay a Dividend of $5