What Is the Net Present Value Of Growth Opportunities?
The net present value of growth opportunities (NPVGO) is a calculation of the net present value per share of all future cash flows involved with growth opportunities such as new projects or potential acquisitions. The net present value of growth opportunities is used to determine the intrinsic value per share of these growth opportunities in order to determine how much of the firm's current per share value is determined by them.
Understanding Net Present Value
Understanding Net Present Value Of Growth Opportunities (NPVGO)
A company's share price may be thought of as the value per share of present and future earnings discounted by the company's cost of capital. Using the dividend discount model, NPVGO may be used to segment that value into the portion that is due to its current earnings and the portion that is due to its earnings from its future growth opportunities. Discounting current earnings per share by the cost of capital will give the value per share of the company's current earnings. Discounting the cash flows expected from growth opportunities will give the value per share due to those growth opportunities.
Example of Net Present Value Of Growth Opportunities (NPVGO)
For example, assume that the intrinsic value of a company's stock is $64.17. If a company's cost of capital is 12% and earnings per share are $5, then the value of those current earnings is $5/.12 = $41.67.
If the expected earnings per share from future growth opportunities is $.90, and the growth rate (g) is 8%, then the value of those earnings is $0.90/(.12 - .08) = $22.50.
The intrinsic value per share of the company is the value per share due to current earnings and the value due to future growth opportunities: $41.67 + $22.50 = $64.17.