Module 29.2 LOS 29.e: The PVGO Equation

When a firm has opportunities to earn returns in excess of its required rate of return it should invest in those opportunities instead of paying dividends. This means that the intrinsic value of the firm is equal to the PV of its future dividends, plus the PV of its growth opportunities.

where:

E1 = earnings at t = 1

r = required return on equity

A substantial portion of the value of growth companies is in their PVGO. In contrast, companies in slow-growth industries (e.g., utilities) have low PVGO, and most of their value comes from their assets in place.

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