Weekly Challenge 4 A

            You are trying to estimate the fundamental growth in earnings for Janus Enterprises for the next 5 years and have obtained the following information:

q      In the most recent year, Janus reported operating income of $ 100 million on book capital invested (at the beginning of the period) of $ 800 million. The firm faced a tax rate of 40% during the period.

q      The firm also reported capital expenditures of $ 140 million and depreciation of $ 100 million in the most recent year. Non-cash working capital increased by $ 10 million during the year.

  1. Estimate the after-tax return on capital last year for Janus.
  2. Estimate the reinvestment rate last year for Janus.
  3. Estimate the expected growth rate for the next 5 years for Janus, assuming that the return on capital and reinvestment rate remain unchanged.
  4. Now assume that Janus will improve its return on capital on new investments for the next 5 years to 15% while the return on capital on existing investments will remain at current levels. Estimate the expected annual growth rate over the 5 years.
  5. How would your answer change if you were told that the return on capital on existing investments will also improve to 15% over the next 5 years (gradually over time)? ( You can assume that the return on new investments will jump to that level in year 1)
  6. Break down your answer to 5 and explain how much of your growth is due to efficiency and how much due to new investments.