PVGO - to grow Earnings or not to grow (Schweser vs CFAI)

I have seen conflicting questions across different sources in regards to this equation:

Vo = E1/r + PVGO

in Schweser practise exam 1 book 2 they use the expected earnings (E1) which is in accordance with the formula above. - they have stated that this company WILL GROW

In CFAI multiples reading EOC 8c they just use E0 instead of growing the earnings.

What is the go here? How do we interpret when to grow earnings or not?

In Schweser book 3 Equity on page 69 thay say that E in the formula stands for no-growth earnings level. Which makes sens imo since the next term is pvgo.

The component on the left of the equation - E/r , is the value of a no-growth company.In this case, E1 = E0, since no growth is assumed.

E1 = E0(1+g) . If growth is assumed to be zero, E1 = E0.

Hrm,

can anybody else clear this up? This is something that looks so simple that i dont think anybody wants to get wrong on exam day.

Exactly! All of the growth opportunities – including the first growth of E0 to E1 – are included in PVGO. E1 = E0 for the nongrowth portion; use E0.

OK then what is the hell is happening here:

"SGC is a small co focusing on new high density paper, which has found application in the aerospace industry. SGC’s earnings and revenues are expected to grow at 30% for eight years, after which time the technology will lose patent protection and SGC’s growth rate will revert to the industry’s growth rate of 3.7%. Last year’s reported earnings were $160.3 million but these earnings are believed to be of poor quality. SGC has never paid dividends. SGC’s earnings can be volatile, but cash flows have been positive and stable.

The fraction of SGC’s market price that is attributable to the value of growth

A) 21%

B) 34%

C) 50%

I initially put 50%

but the answer grows earnings:

$28.45 = ($1.60*1.3)/0.111 + PVGO

PVGO - 9.71

PVGO/Price 9.71/28/45

= 34%

Actually, I think i was wrong in the earlier post. Looking through the CFAI again, the statement below explains better: “The no-growth value per share is defined as E1/r, which is the present value of a perpetuity in the amount of E1 where the capitalization rate, r, is the required rate of return on the company’s equity” The numerator should be the expected earnings, not the current earnings, which makes the above calculation right.

Cool!

I was trying to do this stuff from memory: always a bad approach. I looked back at some of my old Stalla lecture notes (to which I have access now that I’m back home from teaching in Atlanta), and they agree with your assessment.

Thanks for the clarification.

I also think these two bits should be focussed on. If the company is currently paying all it’s earnings as dividends, and revenues/earnings are not expected to grow, then next year’s expected earnings (E1) will be equal to this year’s expected earnings (E0) and you would not need to grow your earnings forward.