Heads-Up13: PVGO

PVGO = Current MV of Stock - Current Period Dividend / Required Return.
The current period divididend / required return is like the intrinsic value, while the remainder is the value of growth opportunity.
 
ABC is an upstart internet retailer that is growing at an extremely fast rate. The firm’s guidance suggests that the dividend growth rate will be high during the next year, and then gradually decline over the next five years to a lower, more sustainable rate. The most recent earnings per share (EPS) was $3.25, and Porter estimates that EPS next year will be $3.90. The estimated required rate of return is 10.25%.If ABC’s shares trade at $45, then the present value of growth opportunities (PVGO) for ABC is closest to:
A. $13.29.
B. $31.71.
c. $6.95.
 
Is it C?
Price = E1 / r + PVGO
45 = 3.9 / .1025 = PVGO
45 = ~38.05 + PVGO
PVGO = ~6.95
 
It says answer is “A”, but again from the link above, as well as my notes, it should be based on EPS1.
 
This was part of the old 2011 ‘Equity Concepts and Techniques’ section which has now been REMOVED from the 2012 LOS??
 
From my studies, I always recall it saying the current year earnings (I mistakenly recalled it saying dividends). In this way, I associated the instrinsic value with a preferred stock.
Forget what random posters say. The only thing that matters is what CFAI says. Do you know what they say?
 
CFAI equity book, pg 221:
V0 = E1 / r + PVGO
Where did you get your question from, which says the answer is A? Schweser? Because that’s what I used to study.
 
Schweser 2012.
But I am glad you posted that from CFAI.
 
Schweser 2012.
But I am glad you posted that from CFAI.
 
Should be A.
You want to separate current value in perpetuity which is EPS / r with the balance being the market implied present value of future EPS growth.
Perpetuity is current income / required rate of return
 
Wow wow wow. This is going to blow up again! Let’s review CFAI text again and make sure we understand exactly what CFAI is saying. It would be nice if we can find a sample question from CFAI that confirms the correct answer as well.
 
Ignore my comment above - read it too fast … I was thinking of franchise value.
BUT this is what I think:
price = PV of perpetuity + PV of growth
rearranging it:
PV of growth = price - PV of perpetuity
PVGO = P - ( E1 / r )
PVGO = 45 - ( 3.90 / 0.1025 ) = ~ 6.95
 
Great work pointing this one out. I always assumed it was E1 (earnings next year) because that’s what the formula alludes to. If you read the CFAI text, it says E1 is t=1 earnings, which is the constant level of earnings or the average earnings of a no-growth company if return on equity is viewed as varying about its average level.
in your example, the next year dividend growth was guided to be high. It is not very clear, but it hints that maybe earnings will be unusually high along with it. Thus, we should use the E0, that is probably more representative of their average earnings.
 
Tricky!
The fine print:

“…The firm’s guidance suggests that the dividend growth rate will be high during the next year, and then gradually decline over the next five years to a lower, more sustainable rate….”

It just means $3.90 isn’t sustainable enough earnings to be used on a perpetuity which implicitly implies no growth cash flows forever …
 
So, basically E1 in a stable growth phase, otherwise E0? That doesn’t make too much sense to me to be honest. If we knew that the firm was experiencing supernatural growth, shouldn’t we just multiply E0 by the long term growth rate then?
It leads me to believe that maybe we should be using E0 always?
 
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