Suppose that a firm has anticipated (i.e. next year) earnings per share of $3.21

Question

Suppose that a firm has anticipated (i.e. next year) earnings per share of $3.21 and a cost of common equity of

15%.

a.) What is the Present Value of Growth Opportunities for the firm if it's common share price is $45?

b.) What does your answer from part a tell you about the firm's growth prospects?

c.) What does your answer form part a tell you about whether the firm is a good buying or (short) selling

opportunity?

d.) What is the Present Value of Growth Opportunities for the firm if it's common share price is $15?

e.) What does your answer from part d tell you about the firm's growth prospects?

f.) What does your answer form part d tell you about whether the firm is a good buying or (short) selling

opportunity?

g.) Repeat parts a through f assuming that the firms earnings per share grow at a 5% fixed, annual rate

and that the earnings per share given earlier (i.e. $3.21) was actually from last year (not next

year's anticipated EPS).

Explanation / Answer

a) Value without growth = 3.21 /.15 =$ 21.40 per share

    Value with growth = $ 45 per share

Present value of growth opportunities= 21.40 - 45

                                                    =- $ 23.60 per share

b)The firm's value will be higher or grow by $23.60 per share if new investment is made.

c)since the company value with investment is higher,it is better to sold the stock.

d) value without investment = 3.21 / .15 = $ 21.40

PVGO = 21.40 - 15 = 6.40

E)The company value will fall by $ 6.40 per share if new investment is made or we can say comapny will have negative growth if new investment is made.

f)It is better to buy stock as stock prices are less than expected price.

g)1 value without investment = 3.21 (1+ .05) / (.15 - .05)

                                          = 3.3705 / .10

                                         = $ 33.705 per share

PVGO = 33.705 - 45 =$ - 11.295 per share

2)Since value of company will be higher by $ 11.295 by making new investment ,growth prospects of company is higher.

3)one should sell the stocks as prices are higher .

4)PVGO = 33.705 - 15 =$ 18.705 per share

5)since value of company is falling by making new investment ,company growth prospects are negative

6)one should buy the stock.

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