# PVGO: check out these 2 questions from Schweser CD

Ambiance Company has a current market price of \$42, a current dividend of \$1.25 and a required rate of return of 12%. All earnings are paid out as dividends. What is the present value of Ambiance’s growth opportunities (PVGO)? A) \$31.58. B) \$38.85. C) \$16.71. answer is A Obsidian Glass Company has current earnings of \$2.22, a required return of 8%, and the present value of growth opportunities (PVGO) of \$8.72. What is the current value of Obsidian’s shares? A) \$36.47. B) \$57.17. C) \$10.94. answer is A Both questions use current earnings, E0 it is, even in our MBA course, we were taught to use E0

“The present value of a perpetuity in the amount of E1 is E1/r where r is the required return on equity and E1 is t=1 earnings, which is the constant level of earnings or the average earnings of a no growth company.” E1 is t=1 E0 is t=o Straight out of the CFAI textbook.

this is one question that will never be settled, I think it is already reported to CFAI

Its gonna get scrapped. I wouldn’t worry about it.

I believe it is E0. E1 is component of PVGO. The idea is similar to E times static PE of the franchise value model.

The weird thing is that they were obviously trying to test whether candidates knew to use E0/E1 because both of the answers from those method were there.

I think it were CFAI, I would have this solution: Choice by using E0: +1; Choice by using E1: +1; The third choice: -2

this is freaky… i know for sure that i had an exact same question in one of the schweser test… and they had both current earnings and expected earnings… i chose E0 as that is what i saw and then got the question wrong…SO i made a mental note to myself… use E1, Use E1 use E1 if it is given… So may be if it is given you alwasy use E1, if not give then go with current E0…

jainan33 Wrote: ------------------------------------------------------- > Ambiance Company has a current market price of > \$42, a current dividend of \$1.25 and a required > rate of return of 12%. All earnings are paid out > as dividends. What is the present value of > Ambiance’s growth opportunities (PVGO)? > > A) \$31.58. > B) \$38.85. > C) \$16.71. > answer is A > > Obsidian Glass Company has current earnings of > \$2.22, a required return of 8%, and the present > value of growth opportunities (PVGO) of \$8.72. > What is the current value of Obsidian’s shares? > > A) \$36.47. > B) \$57.17. > C) \$10.94. > answer is A > > Both questions use current earnings, E0 it is, > even in our MBA course, we were taught to use E0 They use Eo because they assume no growth, hence E1 = E0. If you are given E1, that’s the number you should use as valuation is a forward looking process.

I put E0 and think the answer they were looking for was E1. I think Schweser dropped the ball here. The formula they give and I had in my head was simply E/r + PVGO = Value. They never focussed on the E0 or E1 aspect as they assumed in all their examples, as jainan33 has shown above, that E0 = E1 due to no growth. Like Nirjraina said, the exam was clearly testing if you knew which one to use as both were possible answers.

It’s probably E1, why? Cfai way to get back at those who only use schweser

Check this out(May, 2007): http://www.analystforum.com/phorums/read.php?12,529481,page=1 Disclosure: I got E0.

deriv108 Wrote: ------------------------------------------------------- > Check this out(May, 2007): > > http://www.analystforum.com/phorums/read.php?12,52 > 9481,page=1 > > Disclosure: I got E0. LOL my favourite post is where a guy says “use either one, the answers will almost be the same anyway”

in each one of these questions g=0 aka E0=E1 it’s E1, there is no question about it, the cfa textbook is consistent in that. as much as i’d love for that to happen, they’re not going to drop the question just because people used a 3rd party provider who got it wrong (i got it wrong, 13.5 or whatever)

i bet its supposed to be E2 and CFAI and schweser are both wrong.

it’s kinda funny how we have forum full of smart ppl who are too lazy to open the book. Let’s solve this one once and for all. Page 306 of equity book of CFAI makes it crystal clear you are supposed to use E1 (forecasted earnings). If I fail def reading CFAI books, it makes this questions crystal clear. I’m pretty sure I used E0 on the exam.

Hey Jainan33 - you have the compilations thread on google docs. Would be great if you could send the link again and it seems the same was deleted. Could send at malhotra.ruchi@gmail.com if u could please… thanks so much

Keeping formulae aside for a moment - doesn’t PVGO mean present value of growth? And the E/r mean no-growth value? Now if there is no growth, shouldn’t E(0) be used to compute the E/r? We may memorise zillions of formulae but I guess understanding what they actually mean is the key

FreakazoiD Wrote: ------------------------------------------------------- > Keeping formulae aside for a moment - doesn’t PVGO > mean present value of growth? And the E/r mean > no-growth value? Now if there is no growth, > shouldn’t E(0) be used to compute the E/r? > > We may memorise zillions of formulae but I guess > understanding what they actually mean is the key CFAI book explains it. I thought the same thing as you.

simply go back to the mechanics of the growth model P = (E0 * (1+g))/(r-g) or E1/(r-g) the theory behind the PVGO is to decompose the growth model into intrensic value and the prenst value of growth opertunity so simply decomposing P into: 1- E1/r 2- PVGO which explain the value of prepetual growth of earnings (the r-g term) think of it this way. if company has prepetual growth = 0%, the gordon growth model would become: P = E1/r meaning 0 value for PVGO (present value of growth opertunity) since there is no growth