Calculate the forecast error in earnings per share

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Reference no: EM131508182

The following two companies, Omega Ltd and Kappa Corp, have the following information for the current year:

Omega Ltd Kappa Corp

Current year’s earnings per share $6.31 $0.93

Prior year’s earnings per share $6.24 $1.96

Actual return in share price for the current year 0.072 0.031

We also know that the estimated market model equations for each of these companies is as follows:

For Omega Ltd: E(R) = 0.023 + 0.786 * Rm

For Kappa Corp: E(R) = 0.067 + 1.367 * Rm

Where:

E(R) is the expected return for the company in the current year; and

Rm is the return on the market for the current year.

REQUIRED:

(a) Calculate the forecast error in earnings per share for the current year for both Omega Ltd and Kappa Corp using the random walk model. Show your workings.

(b) Explain briefly what your calculations of the forecast error in earnings per share in part (a) mean for each company.

(c) Calculate the abnormal return in share price for the current year for both Omega Ltd and Kappa Corp if the Rm for the current year is 0.045 (i.e., 4.5%). Show your workings.

(d) Using your answers in parts (a) and (c), explain for Kappa Corp only how the forecast error in earnings per share is related to the abnormal return in share price.

Reference no: EM131508182

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