t 1 B t 1 B t 2 Thus AEG t earn t earnt 1 \u03c1E 1 B t 1 B t 2 earn t \u03c1 E 1B t 1

T 1 b t 1 b t 2 thus aeg t earn t earnt 1 ρe 1 b t 1

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t-1 = B t-1 – B t-2 . Thus, AEG t = earn t – earn t-1 - (ρ E – 1 )[ B t-1 – B t-2 ] = [ earn t - (ρ E – 1)B t-1 ] - [ earn t-1 - (ρ E – 1)B t-2 ] = RE t – RE t-1 So, the AEG model can be written as: 6-53 ] d 1)[earn earn earn 1 t 1 t E 1 t t .... RE RE RE Earn 1 V E E E 2 E E 3 4 2 3 1 0 1
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Protection From Earnings Created by Accounting : A Restructuring Charge 6-54 71 . 133 10 . 1 03 . 1 10 . 1 073 . 0 10 . 1 729 . 8 36 . 20 10 . 0 1 2000 E V
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Abnormal Earnings Growth Analysis: Advantages and Disadvantages Advantages Easy to understand: Investors think in terms of future earnings; investors buy earnings. Focuses directly on the most common multiple used, the P/E ratio. Uses Accrual accounting: embeds the properties of accrual accounting by which revenues are matched with expenses to measure value added from selling products. Versatility: Can be used under a variety of accounting principles (Chapter 17). Aligned with what people forecast: Analysts forecast earnings and earnings growth. Disadvantages Accounting complexity: Requires an understanding of how accrual accounting works. Concept complexity: Requires an appreciation of the concept of cum-dividend earnings; that is, value is based on earnings to be earned within the firm and from earnings from the reinvestment of dividends. Application to strategy: Does not give an insight into the drivers of earnings growth, particularly balance sheet items, so is not suited to strategy analysis. Suspect accounting: Relies on earnings numbers that can be suspect (Chapter 18). 6-55
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