You are looking at the financial statements of CalCo and EdCo, two companies that are traded in an efficient market. These companies are both growing rapidly and are of the same size and risk. As you review their financial statements you notice that while both CalCo and EdCo have the same earnings, but that CalCo has a much more conservative accounting policy regarding development costs. Specifically, CalCo depreciates the capitalized development costs more quickly as compared to EdCo. 

 

a) Which firm's shares will be selling at a higher price-earnings ratio, all other things being equal? Explain your response?

 

b) Now assume you work for and own shares in CalCo? Earnings for the next quarter are going to be released in the coming weeks and you have learned that the earnings release will be great news- better than anyone had thought. You are tempted to use your savings to buy more shares before the earnings release. Outline your arguments for and against this temptation?

Answer rating: 100% (QA)

a EdCo will be selling at a higher priceearnings ratio all other things being equal This is be... View the full answer