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What is meant by Present Value of Growth Opportunities (PVGO)?
Present Value of Growth Opportunities or PVGO represents the component of a company’s share value that relates to expectations of the investors in the growth of earnings. PVGO is the difference between the total value of a company’s shares from which the net present value of its earnings is deducted, assuming there is no growth in the values of the share. PVGO is also known as "value of growth".
A company’s future income can be better represented in two layers: the first layer represents a perpetuity having constant return and the second layer represents the future growth in earnings.
$$\mathrm{𝑉_{0} = PV_{NG} + PVGO}$$
Where PVNG is no-growth earnings’ present value, i.e., the net present value of the accurate straight-line revenue stream. The stream shows the perpetuity of the present value which equals the next year’s earnings (E1) divided by the price of equity (𝑘𝑒).
$$\mathrm{𝑉_{0} =\frac{EPS_{1}}{𝑘_{𝑒}}+ PVGO}$$
By rearranging we can get the formula for PVGO −
$$\mathrm{PVGO = 𝑉_{0} −\frac{EPS_{1}}{𝑘_{𝑒}}}$$
The equation offers an absolute value of PVGO in per-share or total terms. PVGO can be calculated as the proportion of PVGO to total value 𝑉0 too. The equation shows that a higher percentage of PVGO to 𝑉0means most of the company’s net present value results from the shareholders expected growth in the company’s earnings in the market.
A low PVGO may have several reasons −
increased competition,
higher dividend payout,
wrongful estimation of straight-line revenues,
growth of maturity in the industry, etc.
Considerations
The present value growth opportunities (PVGO) is an added sum of all of the present values of present opportunities for future reinvestment. Growth may increase, remain the same, or reduce shareholder wealth based on whether the growth results from earning returns up, equal to, or down from the opportunity cost of funds.
The PVGO is determined by −
The company’s opportunities to re-invest, and
The company’s opportunities to start, enlarge, or abandon future projects.
When retained earnings earn more than the opportunity cost of funds when reinvested, it increases the shareholders' wealth. Companies that have no prospects for investing in positive NPV projects are called "no-growth companies". These companies need to distribute their earnings to shareholders as dividends.
Note − PVGO is an important tool for connecting the company’s future values to its NPV for finding the value of the company in the present circumstances.
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