Page 23 - FINAL CFA II SLIDES JUNE 2019 DAY 7

EXAMPLE: Calculating value with the Gordon growth model READING 29: DISCOUNTED DIVIDEND VALUATION
DownUnder Financial recently paid a dividend of 1.80 Australian dollars
(A$). An analyst has examined the financial statements and historical
dividend policy of DownUnder and expects that the firm’s dividend rate MODULE 29.2: GORDON GROWTH MODEL
will grow at a constant rate of 3.5% indefinitely. The analyst also
determines DownUnder’s beta is 1.5, the risk-free rate is 4%, and the
expected return on the market portfolio is 8%. Calculate the current value
of DownUnder’s shares.

Answer: First use CAPM to estimate DU’s required return:
r = 4% + [1.5 × (8% − 4%)] = 10%

LOS 29.d: Calculate and interpret the implied growth rate of dividends using the Gordon growth model and current stock price: Ready for any variable!

EXAMPLE: Calculating the implied growth rate using the Gordon growth model: Suppose that the current price and most recent annual dividend
for Aurora Mining (AM) are $24.25 and $1.10, respectively. If the required return on Aurora is 8.5%, what is the implied growth rate?

So, assuming that our estimated required return is
on target, the implied growth rate for Aurora
Mining’s dividends is 3.8%.

LOS 29.e: Calculate and interpret the PV of growth opportunities (PVGO) and the component of the leading price-to-earnings ratio (P/E) related
to PVGO.
A firm that has additional opportunities to earn returns in excess of the required rate of return would benefit from retaining earnings and investing in
those growth opportunities rather than paying out dividends.

This means the value of a firm’s equity has two components:
• The value of its assets in place (E /r), which is the present value of a perpetual cash flow of E .
1
1
where: • The present value of its future investment opportunities (PVGO).
E 1 = earnings at t = 1 A substantial portion of the value of growth companies is in their PVGO, otherwise slow-growth industries (e.g., utilities) have low PVGO,
r = required return on equity and most of their value comes from their assets in place.
EXAMPLE: Calculating PVGO: Reliable, Inc.’s shares trade at 60.00 Swiss francs (Sf) with expected EPS of Sf 5.00 and a required return of 10%. Suppose that the
shares are properly priced; so price is equal to fundamental value. Calculate the PVGO and the portion of the leading P/E related to PVGO.