Question

Kirk Inc. has come out with a new and improved product, and is expected to have an EPS of $7.3 and an ROE of 20%. It will maintain a plowback ratio of 28%. Investors expect a 12% rate of return on the stock. Assuming Kirk's current value is measured with the constant growth DDM, compute the present value of growth opportunities for Kirk.

Answer 1

Step-1, Calculation of the Growth Rate (g)

Growth Rate (g) = Return on Equity (ROE) x Plowback Ratio

= 20% x 0.28

= 5.60%

Step-2, Calculation of the Dividend per share (D1)

Dividend per share (D1) = EPS x (1 – Plowback Ratio)

= $7.30 x (1 – 0.28)

= $7.30 x 0.72

= $5.26 per share

Step-3, Calculation of the Current Share Price (PO)

Current Share Price (PO) = D1 / (Ke – g)

= $5.26 / (0.12 – 0.0560)

= $5.26 / 0.0640

= $82.13 per share

Step-4, Calculation of the Present Value of Growth Opportunities (PVGO)

Present Value of Growth Opportunities (PVGO) = Current Share Price – [EPS / Required Rate of Return]

= P0 / [EPS / Ke]

= $82.13 – [$7.30 / 0.12]

= $82.13 - $60.83

= $21.30

“Hence, the Present Value of Growth Opportunities (PVGO) for Kirk would be $21.30”