Implied present value of growth opportunities for firm

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Reference no: EM131495771

Consider two firms with identical required returns of 10%. Firm A has expected earnings of 5 per share over the next year and for every subsequent year and commits to paying out all of those earnings as dividends. Firm B has identical expected earnings to firm A in the next financial year but commits to a policy whereby it always ploughs back 10% of earnings into investment projects. The remaining earnings are paid out as dividends. Its return on equity is 20%.

Compute the market values of the two firms and the implied present value of growth opportunities for firm B.

Explain the source of the difference in the values of the two firms with reference to the underlying data.

Reference no: EM131495771

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