An investor begins a business with a $1,000 investment. The company has these results for the first two years:

• Income of $120 in the first year
• Pays out no dividends in the first year.
• Income of $120 in the second year
• Pays out the entire cumulative income of $240 as dividends, and returns the original $1,000 investment.

The discount rate for this investment is 10 percent. The PV factors for 10% are:

Required:

What are the abnormal earnings for year 1?

What are the abnormal earnings for year 2, keeping in mind that the book value at the beginning of year 2 is the original investment ($1,000) plus the income from year 1 ($120) minus the dividends paid in year 1, (zero) [$1,000+$120-$0=$1,120.]?

What is the PV of the two years of abnormal earnings?

The total cash in the firm at the end of the year 2 is $1,240. As of the initial investment, what is the present value of the $1,240?

How is the present value of the $1,240 related to the present value of the abnormal earnings?

\begin{tabular}{r|r} Year & 10% \\ \hline 1 & 0.90909 \\ \hline 2 & 0.82645 \end{tabular}