Fogell Enterprises is a distributor of superbad tasting Goldslick Vodka. They ar

Question

Fogell Enterprises is a distributor of superbad tasting Goldslick Vodka. They are expected to earn $4.13 per share in the coming year and they have a policy of retaining 12% of profits to fund future growth. Fogell earns a permanent 19% return on any retained earnings plowed back into the business in the following year (i.e. ROE = NIt/Et-1). Investors currently demand a 15% return on similar risk investments. What percentage of the current share price is comes from the value of their growth opportunities (i.e. what is PVGO/Price)?

Explanation / Answer

Growth rate, g = ROE x retention ratio = 19% x 12% = 2.28%

Using constant growth model, Price, P = D1 / (r - g)

Here, Dividend next year, D1 = EPS x (1 - retention ratio) = 4.13 x (1 - 12%) = $3.6344

P = 3.6344 / (15% - 2.28%) = $28.57

PVGO = P - EPS / r = 28.57 - 4.13 / 15% = 1.04

=> PVGO / Price = 1.04 / 28.57 = 3.64%

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