The present value of growth opportunities (PVGO) will be __________ when the return on investment is...

The present value of growth opportunities (PVGO) will be __________ when the return on investment is lower than the cost of equity.

Expert Solution

The present value of growth opportunities (PVGO) will be less when the return on investment is lower than the cost of equity.

(Assumed that the question talk about just present value of Growth Opportunity and not Net present value of Growth Opportunity)

Explanation :

The Present Value of Growth Opportunities (PVGO) is the simply the present value of additional cash flows

Formula for Present value is Future cash flow discounted by Cost of Equity

Where, future Cash flow = cost of project * Return on Investment (1+ Growth rate)

(In absence of information, it is assumed that there is no growth)

If Return of Investment is less that means that the future cash flow will be less. For calculation of PVGO, the future cash flows are required to be calculated based Cost of Equity. Accordingly, the PVGO will be reduced further. Hence PVGO will be less and NPVGO will be negative

Note : * indicates multiplying function

jeff jeffy answered 1 year ago

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