Which of the following situations accurately describes a growth stock,assuming that each firm has a required return of 12%?
A) A firm with PVGO = $0.
B) A firm with investment opportunities yielding 10%.
C) A firm with investment opportunities yielding 15%.
D) All of these firms represent growth stocks.

Question

Quizplus · Accepted Answer

A growth stock is a stock that is expected to grow at a rate significantly higher than the market average. One way to measure this growth potential is by calculating the Present Value of Growth Opportunities (PVGO), which represents the difference between the current stock price and the discounted value of the future cash flows from the firm's growth opportunities. A firm with a positive PVGO is considered a growth stock because investors are willing to pay a premium for its future growth prospects.

In this case, only option C describes a growth stock because the firm has investment opportunities yielding 15%, which is higher than the required return of 12%. This implies that the firm is expected to generate positive net present value from its growth opportunities, leading to a positive PVGO and a higher stock price. Option B may also represent a growth stock, but it is not clear whether the 10% investment opportunities are sufficient to justify a positive PVGO. Option A represents a non-growth stock because its PVGO is zero, indicating that investors do not value its growth prospects. Therefore, the correct answer is C.

Which of the Following Situations Accurately Describes a Growth Stock,assuming