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Ace Ventura, Inc., has expected earnings of $5 per share for next year. The firm's ROE is 15%, and its earnings retention ratio is 40%. If the firm's market capitalization rate is 10%, what is the present value of its growth opportunities

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Answer: $25

Explanation:

The Present value of its growth opportunities can be calculated as the value with growth less the value with no growth.

Value without Growth

= Expected earnings/ Market Cap rate

= 5/0.1

= $50

Value with growth

Growth rate = Retention ratio * ROE

= 0.4 * 0.15

= 6%

Value with growth = (Earnings * (1 - Retention Ratio) )/ (Capitalization Rate - Growth Rate)

= (5 ( 1 - 40%) )/ (10% - 6%)

= 3/0.04

= $75

Present value of growth opportunities = Value with growth - Value without Growth

= 75 - 50

=$25

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