In Reading 33 DDM it states that to calculate PVGO use this formula
Vo = E1/r + PVGO
So i took E1 as Earnings at time 1
In question 8 of the EOC’s (page 174) we have calculated in a) that the sustainable growth rate is 8.4% therefore there is growth in this company. My question is then why are we in c) assuming that this is a 'non growth company (according to the answers). The question doesn’t say anything about it being a non growth company.
When i answered this I grew the earnings by the growth rate i.e
When do you know to assume that the company is a growth or non growth company?
its just breaking up the intrinsic value into 2 parts. part 1= E1/r (this is the value of the company if earnings stayed constant i.e. 0 growth). part 2= the present value of growth ops. so the question asks you to find out the PVGO. You can solve for PVGO by assuming zero growth and solving for E1/r. Once you get E1/r, then you can solve for PVGO using Vo=E1/r + PVGO
E0=E1 because you assume no growth, so earnings stay the same
Where in the question does it say to assume no growth. The first question a) suggests there is a retention ratio of 0.6?
I ran into the same issue, trogulj. Opened an inquiry with the CFAI a couple weeks ago. Still awaiting input… will update this thread once I hear back something.
Not sure what mwmischler is smoking. The question obviously is out of sync with the explanation provided on page 144.
Good luck with that inquiry…
Like has been said, the question is just separating things. The first portion is the value of the firm IF it didn’t grow at all, so we can use E0. Any and all of the growth should be captured in the PVGO, since that’s literally what PVGO is - the value added of growth. So basically you’re just calculating the baseline value of the firm, and then finding what kind of value the growth is adding.
If there were no growth, then PVGO would be zero.
The key to understanding this idea is to separate the two components: value without growth, and value of (only the) growth; the latter is PVGO.
As mentioned above, the value without growth is just a perpetuity, and equals E/r. (It doesn’t matter whether you use E0 or E1; with zero growth, they’re the same.) The remainder of the stock price is PVGO, which could be negative, zero, or positive.