Expected Earnings Growth When There is a Growth Option
Kenton K. Yee
Mellon Capital Management
INTERNATIONAL ACCOUNTING: STANDARDS, REGULATIONS, AND FINANCIAL REPORTING, G. Gregoriou, M. Gaber, eds., Elsevier Ltd, 2006
How does the presence of a growth option affect expected earnings growth? This paper analyzes a firm with one growth option and an accrual accounting policy that, in the absence of a growth option, would equate accounting earnings to Hicksian earnings. Under this accounting policy, the presence of a growth option induces abnormal earnings growth and increases the long run growth rate of expected earnings. Further analysis links the long run growth rate of expected earnings to the option-exercise strategy and the expected lifespan of the option. Implications concerning the relationship between R&D investment, analysts' long run forecasts, and equity valuation are discussed.
Keywords: growth, real options, earnings forecasts, earnings
JEL Classification: M41, G12, G31, G34, G35, D46, H25Accepted Paper Series
Date posted: June 1, 2006
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