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.

- Estimate the after-tax return on capital last year for Janus.
- Estimate the reinvestment rate last year for Janus.
- Estimate the expected growth rate for the next 5 years for Janus, assuming that the return on capital and reinvestment rate remain unchanged.
- 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.
- 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)
- Break down your answer to 5 and explain how much of your growth is due to efficiency and how much due to new investments.