Problem:
Suppose that as you finish a valuation exercise on January 1, 20X1, using the abnormal earnings model, you forecast the abnormal earnings to be $50 at the end of 20X6. From that point, abnormal earnings is expected to grow at 2 percent. The discount rate is 10 percent. The present value factor for a single sum, 5 years, 10%, is 0.681.
Required:
Question 1: What is the present value as of January 1, 20X6 of the abnormal earnings beyond 5 years?
Question 2: What is the present value as of January 1, 20X1 of the abnormal earnings beyond 5 years?
Question 3: Describe one factor that influences how difficult it is to forecast earnings. State how we are to interpret the discount rate.
Note: Be sure to show how you arrived at your answer.