Topic 2 - Valuing Growth Opportunities Flashcards
how do you calculate the stock price for a stock that has dividends grow at different rates in the foreseeable future and then will grow at a constant rate thereafter ?
3 steps
1) Calculate the PV of each irregular dividend separately
2) Estimate the future stock price at the start of the final period when the stock becomes a Constant Growth Stock (case 2); then take its PV
3) Sum the PVs
how is growth calculated?
g = Retention ratio × Return on retained earnings
how is the price of a stock calculated is the firm is a cash cow?
Po = EPS / R
what is the formula for growth opportunities valuation?
(- reinvestment amount + (reinvestment x return on reinvestment%)/ R ) / (R-g)
what two effects will increasing the retention ratio have?
- Reduce the dividend paid to shareholders
- Increase the firm’s growth rate
Reduce the dividend paid to shareholders and increasing the firm’s growth rate have offsetting effects, which will be more dominant?
If ROE>R, then increased retention increases firm value since reinvested capital earns more than the cost of capital.
what is forward PE?
present price divided by EPS one future period
based on the formula, what increases forward PE and what decreases forward PE? (on formula sheet)
Forward P/E is increasing in NPVGO
Forward P/E is decreasing in R (therefore PE is inversely related to risk)
what does it mean if the actual stock price is larger than the stock price calculated using EPS/R?
the firm is not a cash cow
there is a NVPGO component
a percentage of the price is based on market expectations of future growth opportunities
P/B and NPVGO both show growth opportunities, which is preferred?
NPVGO benchmarked against required rate of return.
What is economic value added EVA?
an accounting performance measure that explicitly recognizes the cost of contributed capital
what does it mean if EVA is more or less than zero?
EVA ≥ 0 indicates capital cost has been covered
EVA
