But we don’t knwo what the growth rate is!
just a sec guys the formula in schwesser clearly says V0=E/r +PVGO where E = No Growth Earnings Level so the it works out to be PVGO= 45-3.25/0.1025
Honestly, Schweser is my bff. I trust him…
Hopefully we aren’t presented with answers derived from E0 and E1 on the exam.
Trekker has the intuition right (as I contradict my answer earlier). The answer probably depends on what point in the year you are looking at also. Using the guidance the company has given, the analyst has forecasted earnings per share to be 3.90, while the only thing you really know about the value of the assets in place is that they are 3.25 (CFA says E1 can be interpreted as the per-share value of the assets in place if the company make no new investments). Notice the question doesn’t say anything about “according to the analyst”.
In a situation where there is no growth this year, E0(1+0) = E0. Question 8 from pg 256 is worded similarly, and while they don’t give a time, justify using the recent earnings mentioned
the formula is based on current year earnings, E0, so you can seperate how much of the current stock value is based on growth opps vs. required rate of return
Sorry folks …it’s always E1 CFAI clearly states that no growth company is one whose growth does not exceed sustainable growth… I’d like to understand it as > 6% when 6 is perpetuity.
In this case, e1= 3.90 estimate. The analyst is sitting and thinking that the company has NPV of projects > 0, so I could bring it upto 3.90. So rather than distribute, the company is going to use it the earnings up and increase the share holders wealth. Given the guidance, its going to run out of those opportunities within 5 years (when Pvgo is expected to diminish ).
The market priced it 6.95 worth ( real options) in it beyond perpetuity.
I believe a) is wrong if the question is stated it as is.
my .02
CFA Vol 3 page 256, Question 8C. Essentially the same question, and they (CFAI) clearly use the most recent earnings (which, they point out to be the same in the next period as they state the formula uses E1)
In order to get to 3.90 from 3.25, there has to be growth in the firm within the year. If you’re assuming no growth, the EPS must stay the same (because they’ve paid out the 3.25 as dividends and so b * ROE = 0)
And in either case, the market wouldnt have priced it at 6.95 - it’s the analyst that is assuming EPS of 3.9. The question makes no statement about the market assumption of earnings. All you know is that given recent earnings, the market price is 45. If you assume no growth, E1 = E0 and E1 / r = 3.25 / .1025
Based on all the sample questions I’ve actually seen and calculated and reviewed, it’s always been E0. I have never noticed whether the firm was presumably no growth.
Has anyone run across an example (preferrable in CFAI, or in any text at all) where the firm is in a stable growth phase, and the correct answer involved using E1?
The firm doesnt have to be no growth for calculating PVGO - in fact for a no growth firm, PVGO is theoritically zero. E/r in the formula has to be current earnings divided by the required return on the stock. This value would be the value of the stock assuming the earnings do not grow at all going forward. Then the difference of this with the actual stock price gives PVGO.
The firm doesnt have to be no growth for calculating PVGO - in fact for a no growth firm, PVGO is theoritically zero. E/r in the formula has to be current earnings divided by the required return on the stock. This value would be the value of the stock assuming the earnings do not grow at all going forward. Then the difference of this with the actual stock price gives PVGO.
The firm doesnt have to be no growth for calculating PVGO - in fact for a no growth firm, PVGO is theoritically zero. E/r in the formula has to be current earnings divided by the required return on the stock. This value would be the value of the stock assuming the earnings do not grow at all going forward. Then the difference of this with the actual stock price gives PVGO.
So no one has a consensus on this?
I had seen a question in one of the schweser practice exams. In order to calculate the PVGO they used leading P/E (which has no G) , they had used E1 and not E0. So, I am thinking that in this case, we use E0.
Consensus? I’m using E0, because that’s all I’ve ever seen in practice questions. If someone presents an example that uses E1, and reference where the example is found I may reconsider. If I fail because of this, then f*** it!
I think we’re all getting confused because the book uses E1 (as do most formulas), but then in the example everything is based off of some earnings number from the previous year or give some random statement as in “earnings in 2008 were x.xx per share, and required return = yy%, and market price is $zz, so calculate PVGO”
It seems like the notation just uses E1 because that’s how a perpetuity is valued, and it only makes sense that there is some consistency across formulas. You never value a cash flow (in any of the equity valuations or anywhere else) that discounts the cash flow received today or “from 2008” - ie the past.
The earnings they give, and that CFAI alludes to are that you’re given some recent earnings, which is a pretty fair representation of the earnings power of the “assets currently in place”. The market price reflects the market consensus of the growth potential of the firm, which is an aggregration of all future potential cash flows from the firm.
In reality, if you’re in the middle of March, you don’t know anything about the earnings at the end of the year… its ALWAYS a forecast based on some growth rate, etc. So, given no growth, the only valid assumption you can make is that in the absence of growth (including negative growth), earnings per share in the current period should be exactly equal to the earnings in the next period. If you assume E1 is different from E0, than there has to have been growth, positive or negative.
The original question gives E0, but also gives some random analyst’s estimate of E1… it doesnt matter if the analyst ia professional at a bulge bracket or some 5 year old throwing darts. You can only make assumptions about the assets in place based of off recent concrete earnings, which should logically stay the same in the absense of any growth