Flanders Ltd has expected earnings of $4 per share for next year. The firm's ROE is 8% and its earnings retention ratio is 40%. If the firm's market capitalisation rate is 15%, what is the present value of its growth opportunities?

Question

Quizplus · Accepted Answer

The present value of growth opportunities (PVGO) is calculated as the difference between the price of the stock with growth and the price of the stock without growth. The growth rate (g) is ROE * retention ratio = 8% * 40% = 3.2%. The price without growth is earnings per share / market capitalization rate = $4 / 0.15 = $26.67. The price with growth is calculated using the Gordon Growth Model: $4 * (1 + 0.032) / (0.15 - 0.032) = $20.34. Therefore, PVGO = $20.34 - $26.67 = -$6.33.

Flanders Ltd Has Expected Earnings of $4 Per Share for Next