Next year's earnings are estimated to be $5.00.The company plans to reinvest 20% of its earnings at 15%.If the cost of equity is 9%,what is the present value of growth opportunities?

Question

Quizplus · Accepted Answer

The present value of growth opportunities can be calculated by using the Gordon Growth Model as follows:

PVGO = (Reinvestment Rate / Cost of Equity - Growth Rate) x EPS

Reinvestment Rate = 20% 
Return on Reinvestment (i.e. rate at which earnings are reinvested) = 15% 
Cost of Equity = 9% 
Growth Rate = Return on Reinvestment x Reinvestment Rate = 15% x 20% = 3% 
EPS = $5

Plugging these values into the equation, we get:

PVGO = (0.20 / 0.09 - 0.03) x $5 
PVGO = $11.11

Therefore, the present value of growth opportunities is $11.11, which is option C).

Next Year's Earnings Are Estimated to Be $5