Equity Valuation Models?

The present value of growth opportunities (PVGO) is equal to which of the following

A. the difference between a stock's price and its no-growth value per share.
B. zero if its return on equity equals the discount rate.
C. the net present value of favorable investment opportunities.
D. all of the above
E. none of the above

Please explain the reason behind.

Ans. D. All of the above.

Explanation:

The dividend discount model values a stock on the basis of dividends paid, growth in dividends and a required return. If the company is not expected to grow, the rational response would be to pay out all earnings as dividends. In such circumstances, the value should reflect the current earnings divided by the required return, or E/r. This is the no-growth value per share.

Since we know what the value of a stock should be if it does not grow, we can also infer how much value the market is assigning to future growth opportunities. The total value must is V = E/r + PVGO where E/r is the no-growth value and PVGO is the present value of growth opportunities.

Consider, for example, a stock earning $1.00 per share with an 8% required return. If the stock is currently trading at $20.00 per share, we can compute a no-growth value of $12.50 and a PVGO of $7.50.

Further, it is important to recognize that growth per se is not what investors desire. Growth enhances company value only if it is achieved by investment in projects with attractive profit opportunities i.e., with ROE greater than the market capitalization rate or discount rate. In other words, if ROE = r, PVGO = 0.