Financial Statement Analysis Workbook, 5th Edition

Computational Exercises

THE ARITHMETIC OF GROWTH VALUATIONS

Using a simple framework we call “the arithmetic of growth valuations,” we explore the consequences for the owner's wealth of changing in expectations regarding the corporation's earnings growth. We provide four numerical examples to illustrate this point. The reader will be well served by coming back to these simple examples and working through the consequences of the strategies and schemes presented throughout the book.

1. Q1. A corporation is currently reporting annual net earnings of $30.0 million. Assume that five years from now, when its growth has leveled off somewhat, the corporation will be valued at 15 times earnings.

Further assume that the company will pay no dividends over the next five years and that investors in growth stocks currently seek returns of 25 percent (before considering capital gains taxes). Suppose the corporation's earnings have been growing at a 15 percent annual rate and appear likely to continue increasing at the same rate over the next five years.

At the end of that period, earnings (rounded) will be $_____ million annually. Applying a multiple of 15 times to that figure produces a valuation at the end of the fifth year of $____ million. Investors seeking a 25 percent rate of return will pay $_____ million today for that future value.

Say the founder still owns 20 percent of the shares outstanding, which means she is worth $_____ million. Suppose investors conclude for some reason ...