As discussed in the chapter, abnormal earnings (AE) are AE t = X t (r e
Question:
As discussed in the chapter, abnormal earnings (AE) are
AE t = X t − (r e × BV t−1 )
where X t is the firm’s net income, r e is the cost of equity capital, and BV t-1 is the book value of equity at t − 1.
Following are X t , BV t-1 , and r e for two firms.
Company A | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||
X t | $ | 66,920 | | $ | 79,632 | | $ | 83,314 | | $ | 89,920 | | $ | 92,690 | |
BV t− 1 | | 478,000 | | | 504,000 | | | 541,000 | | | 562,000 | | | 598,000 | |
r e | | 0.152 | | | 0.167 | | | 0.159 | | | 0.172 | | | 0.166 | |
|
Company B | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||
X t | $ | 192,940 | | $ | 176,341 | | $ | 227,700 | | $ | 198,900 | | $ | 282,964 | |
BV t−1 | | 877,000 | | | 943,000 | | | 989,999 | | | 1,020,000 | | | 1,199,000 | |
r e | | 0.188 | | | 0.179 | | | 0.183 | | | 0.175 | | | 0.186 | |
|
Required:
Calculate each firm’s AE t each year from 2013 to 2017. (Round your final answers to the nearest whole dollar. Negative abnormal earnings should be indicated with a minus sign.)
Which firm was better managed over the 2013–2017 period?
Which firm is likely to be the better stock investment in 2018 and beyond?
Financial Reporting and Analysis
ISBN: 978-1259722653
7th edition
Authors: Lawrence Revsine, Daniel Collins, Bruce Johnson, Fred Mittelstaedt, Leonard Soffer