What Is the Net Present Value of Growth Opportunities (NPVGO)?
Let me explain NPVGO directly: it's a calculation of the net present value per share for all future cash flows from growth opportunities, such as new projects or potential acquisitions. You use it to figure out the intrinsic value per share of these opportunities and see how much of the firm's current per-share value comes from them.
To compute NPVGO, take the projected cash inflow, discount it at the firm's cost of capital, and subtract the initial investment or purchase price of the project or asset.
Understanding Net Present Value of Growth Opportunities (NPVGO)
Think of a company's share price as the value per share of present and future earnings, discounted by the cost of capital. With the dividend discount model, NPVGO lets you break that down into the part from current earnings and the part from future growth opportunities.
Discount current earnings per share by the cost of capital to get the value per share from current earnings. Then, discount the expected cash flows from growth opportunities to find the value per share from those. This approach helps you determine the incremental value of an acquisition or new project.
You can use NPVGO to negotiate acquisition prices or estimate the market value assigned to a company's future growth. Remember, it's based on projections, so exclude nonstandard cash flows like those from discontinued or nonrecurring operations to avoid skewing results. Accurate projections are crucial for key business decisions.
Also, assess whether an NPVGO is high or low within its industry context. Factors like technology and capital vary by sector, so valuations are industry-specific—keep that in mind when calculating.
Example of Net Present Value of Growth Opportunities (NPVGO)
Here's a straightforward example: suppose a company's intrinsic stock value is $64.17. If the cost of capital is 12% and earnings per share are $5, the value from current earnings is $5 divided by 0.12, which equals $41.67.
If expected earnings per share from future growth is $0.90 with a growth rate of 8%, the value from those earnings is $0.90 divided by (0.12 minus 0.08), equaling $22.50.
Add them up: $41.67 plus $22.50 gives the intrinsic value per share of $64.17, showing the split between current earnings and future growth opportunities.
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