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As discussed in the chapter, abnormal earnings (AE) are AEt = Xt - (rex BVt-1) where Xt is the firm's net income, re is the cost of equity capital, and BV+-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.) 1. If Xt is $5,000, re = 15%, and BV+-1 is $50,000, what is AE+? 2. If Xt is $25,000, re = 18%, and BV+-1 is $125,000, what is AEt? 3. Assume the firm in requirement 2 can increase Xt to $30,000 by instituting some cost-cutting measures. What is the new AE+? 4. Assume the firm in requirement 2 can divest $25,000 of unproductive capital with X+ falling by only $2,000. What is the new AE+? 5. Assume the firm in requirement 2 can add a new division at a cost of $40,000, which will increase Xt by $7,600 per year. Would adding the new division increase AE+? 6. Assume the firm in requirement 1 can add a new division at a cost of $25,000, which will increase Xt by $3,500 per year. Would adding the new division increase AEt? 1. AEt 2. AEt 3. 2345 4. 5. 6. AEt AEt Would adding the new division increase AEt? Would adding the new division increase AEt?

As discussed in the chapter, abnormal earnings (AE) are AEt = Xt - (rex BVt-1) where Xt is the firm's net income, re is the cost of equity capital, and BV+-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.) 1. If Xt is $5,000, re = 15%, and BV+-1 is $50,000, what is AE+? 2. If Xt is $25,000, re = 18%, and BV+-1 is $125,000, what is AEt? 3. Assume the firm in requirement 2 can increase Xt to $30,000 by instituting some cost-cutting measures. What is the new AE+? 4. Assume the firm in requirement 2 can divest $25,000 of unproductive capital with X+ falling by only $2,000. What is the new AE+? 5. Assume the firm in requirement 2 can add a new division at a cost of $40,000, which will increase Xt by $7,600 per year. Would adding the new division increase AE+? 6. Assume the firm in requirement 1 can add a new division at a cost of $25,000, which will increase Xt by $3,500 per year. Would adding the new division increase AEt? 1. AEt 2. AEt 3. 2345 4. 5. 6. AEt AEt Would adding the new division increase AEt? Would adding the new division increase AEt?

Intermediate Financial Management (MindTap Course List)
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter11: Determining The Cost Of Capital
Section: Chapter Questions
Problem 3Q
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As discussed in the chapter, abnormal earnings (AE) are AEt = Xt - (rex BVt-1) where Xt is the firm's net income, re is the cost of equity capital, and BV+-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.) 1. If Xt is $5,000, re = 15%, and BV+-1 is $50,000, what is AE+? 2. If Xt is $25,000, re = 18%, and BV+-1 is $125,000, what is AEt? 3. Assume the firm in requirement 2 can increase Xt to $30,000 by instituting some cost-cutting measures. What is the new AE+? 4. Assume the firm in requirement 2 can divest $25,000 of unproductive capital with X+ falling by only $2,000. What is the new AE+? 5. Assume the firm in requirement 2 can add a new division at a cost of $40,000, which will increase Xt by $7,600 per year. Would adding the new division increase AE+? 6. Assume the firm in requirement 1 can add a new division at a cost of $25,000, which will increase Xt by $3,500 per year. Would adding the new division increase AEt? 1. AEt 2. AEt 3. 2345 4. 5. 6. AEt AEt Would adding the new division increase AEt? Would adding the new division increase AEt?
Transcribed Image Text:As discussed in the chapter, abnormal earnings (AE) are AEt = Xt - (rex BVt-1) where Xt is the firm's net income, re is the cost of equity capital, and BV+-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.) 1. If Xt is $5,000, re = 15%, and BV+-1 is $50,000, what is AE+? 2. If Xt is $25,000, re = 18%, and BV+-1 is $125,000, what is AEt? 3. Assume the firm in requirement 2 can increase Xt to $30,000 by instituting some cost-cutting measures. What is the new AE+? 4. Assume the firm in requirement 2 can divest $25,000 of unproductive capital with X+ falling by only $2,000. What is the new AE+? 5. Assume the firm in requirement 2 can add a new division at a cost of $40,000, which will increase Xt by $7,600 per year. Would adding the new division increase AE+? 6. Assume the firm in requirement 1 can add a new division at a cost of $25,000, which will increase Xt by $3,500 per year. Would adding the new division increase AEt? 1. AEt 2. AEt 3. 2345 4. 5. 6. AEt AEt Would adding the new division increase AEt? Would adding the new division increase AEt?
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