Refer back to the valuation in Exercise 5.3. In that pro form a, an analyst forecast $388 million of earnings
Refer back to the valuation in Exercise 5.3. In that pro form a, an analyst forecast $388 million of earnings for 2010 on a book value at the end of 2009 of $4,310 million, that is, a return on common equity of 9 percent. The forecasts were made at the end of 2009 based on preliminary reports from the firm.
When the final report was published, however, the analyst discovered that the firm had decided to write-down its inventory at the end of 2009 by $114 million (following the lower-of-cost-or-market rule).As this was inventory that the analyst forecasted would be sold in 2010 (and thus the impairment affects cost of goods sold for that year), the analyst revised her earnings forecast for 2010. For questions (a) and (b), ignore any effect of taxes.
a. What is the revised earnings forecast for 2010 as a result of the inventory impairment assuming no change in the sales forecast? What is the revised forecast of return on common equity (ROCE) for 2010?
b. Show that the revision in the forecast of 2010 earnings does not change the valuation of the equity.
c. Recognize, now, that the firm's income tax rate is 35 percent. Do your answers to questions (a) and (b) change?
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