Determining abnormal earnings-Some examples (LO6-1) As discussed in the chapter, abnormal earnings (AE) are AE t =
Question:
Determining abnormal earnings-Some examples (LO6-1)
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 time t − 1.
Required:
Solve the following problems: (Negative amounts for any of your answers should be indicated by a minus sign.)
If X t is $5,000, r e = 15%, and BV t-1 is $50,000, what is AE t ?
If X t is $25,000, r e = 18%, and BV t-1 is $125,000, what is AE t ?
Assume the firm in requirement 2 can increase X t to $30,000 by instituting some cost-cutting measures. What is the new AE t ?
Assume the firm in requirement 2 can divest $25,000 of unproductive capital with X t falling by only $2,000. What is the new AE t ?
Assume the firm in requirement 2 can add a new division at a cost of $40,000, which will increase X t by $7,600 per year. Would adding the new division increase AE t ?
Assume the firm in requirement 1 can add a new division at a cost of $25,000, which will increase X t by $3,500 per year. Would adding the new division increase AE t ?
1. AEt
2. AEt
3. AEt
4. AEt
5. Would adding the new division increase AEt?
6. Would adding the new division increase AEt?
Financial Reporting and Analysis
ISBN: 978-1259722653
7th edition
Authors: Lawrence Revsine, Daniel Collins, Bruce Johnson, Fred Mittelstaedt, Leonard Soffer