During the 1990s, GTR Corporation put together a long string of consecutive quar

Question

During the 1990s, GTR Corporation put together a long string of consecutive quarters in which the firm managed to meet or beat the earnings forecasts of Wall Street stock analysts. Some skeptics wondered if GTR “managed” earnings to meet Wall Street’s expectations, meaning that GTR used accounting gimmicks to conceal the true volatility in its business. How do you think GTR’s long run of meeting or beating earnings forecasts affected its cost of capital? If investors learn that GTR’s performance was achieved largely through accounting gimmicks, how do you think they would respond?

Explanation / Answer

If GTR is able to beat earnings forecast in the long run, forecast would also adjust accordingly. If forecasts do not adjust or GTR is able to beat even adjusted forecasts then share price would go up which in turn would drive the cost of capital down. In other words, if forecasts are exceeded, then more and more investor would want to buy GTR stock and hence cost of capital would come down.

If it comes to be known that performance was not actual but through manipulation, they would lose confidence in the stock and would start selling thus decreasing the share price.

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