Selected data are presented below for two companies. Company A Company B Actual earnings $ 79 , 632 $ 176 , 341 B V t − 1 $ 504 , 000 $ 943 , 000 Cost of equity capital 0.167 0.175 \begin{array}{lrr} & ext { Company A } & ext { Company B }\ ext { Actual earnings } & \$ 79,632 & \$ 176,341 \B V_{t-1} & \$ 504,000 & \$ 943,000 \ ext { Cost of equity capital } & 0.167 & 0.175\end{array} Actual earnings B V t − 1 Cost of equity capital Company A $79 , 632 $504 , 000 0.167 Company B $176 , 341 $943 , 000 0.175 Required:Calculate each firm's abnormal earnings and indicate which firm was better managed during the year in question.

Question

Selected data are presented below for two companies.  Company A   Company B   Actual earnings  $ 79 , 632 $ 176 , 341 B V t − 1 $ 504 , 000 $ 943 , 000  Cost of equity capital  0.167 0.175 \begin{array}{lrr} & 	ext { Company A } & 	ext { Company B }\	ext { Actual earnings }  &  \$ 79,632  &  \$ 176,341 \B V_{t-1}  &  \$ 504,000  &  \$ 943,000 \	ext { Cost of equity capital }  &  0.167  &  0.175\end{array}  Actual earnings  B V t − 1 ​  Cost of equity capital  ​  Company A  $79 , 632 $504 , 000 0.167 ​  Company B  $176 , 341 $943 , 000 0.175 ​ Required:Calculate each firm's abnormal earnings and indicate which firm was better managed during the year in question.

Taufiq Mahmud Masum · Accepted Answer

Final Answer :   Company A   Company B   Actual earnings  $ 79 , 632 $ 176 , 341 B V t − 1 504 , 000 943 , 000  Cost of equity capital  0.167 0.175  Return on capital  0.158 0.187  Expected earnings  84 , 168 165 , 025  Abnormal earnings  ( $ 4 , 536 ) $ 11 , 316 \begin{array}{lrr} & 	ext { Company A } & 	ext { Company B }\	ext { Actual earnings }  &  \$ 79,632  &  \$ 176,341 \B V_{t-1}  &  504,000  &  943,000 \	ext { Cost of equity capital }  &  0.167  &  0.175 \	ext { Return on capital }  &  0.158  &  0.187 \	ext { Expected earnings }  &  84,168  &  165,025 \	ext { Abnormal earnings }  &  (\$ 4,536)  &  \$ 11,316\end{array}  Actual earnings  B V t − 1 ​  Cost of equity capital   Return on capital   Expected earnings   Abnormal earnings  ​  Company A  $79 , 632 504 , 000 0.167 0.158 84 , 168 ( $4 , 536 ) ​  Company B  $176 , 341 943 , 000 0.175 0.187 165 , 025 $11 , 316 ​   Company B created value by generating positive abnormal earnings while Company A actually destroyed value via negative abnormal earnings;thus,Company B was the better managed of the two in the year in question.

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