Company A and Company B both start 2012 with $1 million of shareholders’ equity and 100,000 shares of common stock outstanding. During 2012, both companies earn net income of $100,000, a return of 10% on common shareholders’ equity at the beginning of 2012. Company A declares and pays $100,000 of dividends to common shareholders at the end of 2012, whereas Company B retains all its earnings and declares no dividends. During 2013, both companies earn net income equal to 10% of shareholders’ equity at the beginning of 2013.
a. Compute earnings per share for Company A and for Company B for 2012 and for 2013.
b. Compute the rate of growth in earnings per share for Company A and Company B, comparing earnings per share in 2013 with earnings per share in 2012.
c. Using the rate of growth in earnings per share as the criterion, which company’s management appears to be doing a better job for its shareholders? Comment on this result.
d. Using the change in return on equity (discussed in Chapter 7) as the criterion, which company’s management appears to be doing a better job for its shareholders? For this purpose, use the beginning balance of shareholders’ equity to calculate return on equity. Comment on this result.