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Consider the following two earnings forecasting models: Model 1 (Random walk model) E t (EPS t+1 ) = EPS t Model 2 (Mean-reverting model) E

Consider the following two earnings forecasting models:

Model 1 (Random walk model) Et(EPSt+1) = EPS t

Model 2 (Mean-reverting model) Et(EPSt+1) =

Et(EPSt+1) is the EPS forecast for year t+1, given the information available at t.

The EPS for TJX for the fiscal years ending January 2006 (FY2005) through January 2010 (FY2009) are:

Fiscal Year 2005 2006 2007 2008 2009
EPS $1.40 $1.60 $1.70 $2.00 $2.80

Part a): What would be the EPS forecast in FY2010 for each model?

  • Model 1 (random walk model):

  • Model 2 (mean-reverting model):

Part b): Actual EPS for TJX in FY2010 was $3.30. Given this information:

  • What would be the FY2011 forecast for earnings per share for each model?

  • Why do the two models generate quite different forecasts?

  • Which model (random walk or mean-reverting) do you think better describes TJXs earnings per share patterns? Explain.

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