The following quote was taken from a recent annual report of The Quaker Oats Company: (Financial performance objectives in terms of earning power and solvency) Any review of Quaker'sfinancial performance over the last six years must be seen in the context of the financial objectives we have set. The financial objectives, which commit us to achieving a balance of returns and growth and thus measure our success in providing value to the stockholders, are to: 1. achieve a return on equity at 20 percent or above. 2. achieve “real ” earnings per share growth averaging 5 percent or better. 3. increase Quaker’s dividend, consistent with “real” earnings growth, and 4. maintain a strong financial position, as represented by Quaker’s current bond and commercial paper ratings. REQUIRED:

a. Define return on equity and explain why Quaker Oats might express a financial objective in terms of it.

b. Objectives 2 and 3 above refer to “real” earnings per share and “real” earnings growth. Normally, designating a performance measure as “real” indicates that the effect of infla¬ tion has been removed from it. Why would Quaker Oats want to remove the effect of infla¬ tion from reported earnings numbers in its statement of objectives?

c. Which objectives above refer to measures of earning power and which refer to measures of solvency? Define and differentiate between these two concepts, and explain how each objective above relates to either earning power or solvency.