What is the most likely value of the PRESENT VALUE OF GROWTH OPPORTUNITIES for a stock with current price of $50, expected earnings of $6 per share, and a required return of 20 percent?
A)$10
B)$20
C)$25
D)$30

Question

Quizplus · Accepted Answer

To calculate the Present Value of Growth Opportunities (PVGO), we need to subtract the present value of the expected dividends from the current stock price. 
PVGO = Current Stock Price - Present Value of Expected Dividends 
We can calculate the present value of expected dividends using the Gordon Growth Model: 
Expected Dividend = Expected Earnings x Payout Ratio
Payout Ratio = 1 - Retention Ratio
Retention Ratio = 1 - Dividend Payout Ratio
Dividend Payout Ratio = Dividends per Share / Earnings per Share
Expected Dividend Growth Rate = Retention Ratio x Return on Equity
Expected Dividend / (Required Return - Expected Dividend Growth Rate)
Given the information, 
Expected Dividend = 6 x (1 - 0.4) = 3.6 per share 
Dividend Payout Ratio = 2.4 / 6 = 0.4 
Retention Ratio = 1 - 0.4 = 0.6 
Expected Dividend Growth Rate = 0.6 x 0.20 = 0.12
Present Value of Expected Dividends = 3.6 / (0.20 - 0.12) = 36 
PVGO = 50 - 36 = 14 
Therefore, the closest value to the PVGO is $20, which is answer choice B.

What Is the Most Likely Value of the PRESENT VALUE