I am struggling a bit with the computation of PVGO. I have seen 3 different approaches so far and I am trying to reconcile them:
V0=E1/r+PVGO (this is the formula I am familiar with)
V0=D1/r+PVGO (from one of Schweser Mocks)
Compute the difference between 1) and 2), from one of the CFAI Topic Tests.
Can someone help?
The no-growth firm pays 100% of its earnings as dividends.
Technically, it’s either, but go with E1/r for the sake of the exam. Remember, with the PVGO formula, all earnings are paid out as dividends. Therefore, E1 = D1.
The formula IS confusing to me, though. If E1/r is no-growth, E1 shouldn’t be E0 * (1+g), but I digress…
No. 1. correct.
No. 2. should be: earnings equal dividends as all is paid out as dividends - this is the no growth asumption
No 3. I remember differently
from a topic test. You need to calculate a value with a growth assumption theory (DDM) then deduct E1/r to have the PVGO.
Gosh! 3 answers within 1 minute.
I’m off to sleep now, goodnight! 5 more days to go.
3 answers within a minute is indeed impressive. Thanks everyone, that helped.
Hi, i’m trying to understand the logic behind this formula of a company with no growth. V0 = E1/r how does dividing your EPS by your required rate of return become your valuation? It sounds like just discounting your earnings by 1 year?
It’s the formula for the value of a perpetuity; you learned it at Level I.
The formula is saying to you that the company will be paying into perpetuity all of its earnings (the model assumes earnings to be the same each consecutive year, that is why E1 (which = D1). It is the same principle as how we value a non-callable fixed paying preferred share or a perpetuity payment (from Quant L1), that is, cash flow/rate.
V0= E1/(Ke-g) … but they have zero growth (g= 0) because they have no investment opportunities to create shareholder wealth (positive NPV projects), therefore the company is paying all of its earnings to common shareholders, that is a dividend payout ratio of 100%.
Thanks, it’s been a couple years since i took lvl1 so a bit rusty.
I also looked up more on perpetuity and also helped to know the original summation formula is essentially an infinite geometric series that converges to simplify to the E1/r.