Question: Residual Earnings Valuation and Accounting Methods (Hard) Refer back to the valuation. In that proforma, an analyst forecast $388 million of earnings for 2013 on a book value at the end of 2012 of $4,310 million, that is, a return on common equity of 9 percent. The forecasts were made at the end of 2012 based on preliminary reports from the firm. When the final report was published, however, the analyst discovered that the firm had decided to write-down its inventory at the end of2012 by $114 million (following the lower of-cost-or-market rule). As this was inventory that the analyst forecasted would be sold in 2013 (and thus the impairment affects cost of goods sold for that year), the analyst revised her earnings forecast for 2013. For questions (a) and (b), ignore any effect of taxes.
a. What is the revised earnings forecast for 2013 as a result of the inventory impairment assuming no change in the sales forecast? What is the revised forecast of return on common equity (ROCE) for 2013?
b. Show that the revision in the forecast of2013 earnings does not change the valuation of the equity.
c. Recognize, now, that the firm's income tax rate is 35 percent. Do your answers to questions (a) and (b) change?