abnormal earnings (AE) are AEt = Xt (re BVt1) ...
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Accounting
abnormal earnings (AE) are
AEt = Xt (re BVt1)
where Xt is the firms net income, re is the cost of equity capital, and BVt-1 is the book value of equity at t 1.
Following are Xt, BVt-1, and re for two firms.
| Company A | 20X1 | 20X2 | 20X3 | 20X4 | 20X5 | ||||||||||
| Xt | $ | 66,920 |
| $ | 79,632 |
| $ | 83,314 |
| $ | 89,920 |
| $ | 92,690 |
|
| BVt1 |
| 478,000 |
|
| 504,000 |
|
| 541,000 |
|
| 562,000 |
|
| 598,000 |
|
| re |
| 0.152 |
|
| 0.167 |
|
| 0.159 |
|
| 0.172 |
|
| 0.166 |
|
|
| |||||||||||||||
| Company B | 20X1 | 20X2 | 20X3 | 20X4 | 20X5 | ||||||||||
| Xt | $ | 192,940 |
| $ | 176,341 |
| $ | 227,700 |
| $ | 198,900 |
| $ | 282,964 |
|
| BVt1 |
| 877,000 |
|
| 943,000 |
|
| 989,999 |
|
| 1,020,000 |
|
| 1,199,000 |
|
| re |
| 0.188 |
|
| 0.179 |
|
| 0.183 |
|
| 0.175 |
|
| 0.186 |
|
|
| |||||||||||||||
Required:
Calculate each firms AEt each year from 20X1 to 20X5. (Round your final answers to the nearest whole dollar. Negative abnormal earnings should be indicated with a minus sign.)
Was Company B better managed over the 20X120X5 period?
Is Company B likely to be the better stock investment in 20X6 and beyond?
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