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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Kestrel Foods plc reports rising earnings per share for four consecutive years. However, its return on capital employed is 7%, while investors require a return of 11% on the capital they have supplied. Which conclusion best applies the shareholder value concept to Kestrel?

Kestrel is destroying shareholder value because its 7% return is below the 11% return investors require. Rising EPS does not show value creation, since it ignores the cost of the capital employed. Value is created only when returns exceed the cost of capital.

  1. AShareholder value is being created because EPS is rising
  2. BShareholder value is being destroyed because returns are below the cost of capitalCorrect
  3. CShareholder value is unaffected because EPS growth offsets the shortfall
  4. DShareholder value cannot be assessed without knowing the dividend payout ratio

Explanation

Shareholder value is created only when returns exceed the cost of capital. Kestrel earns 7% against a required 11%, so it is destroying value despite rising EPS, which can be inflated by retained earnings or accounting choices. Option A relies on EPS, which ignores the cost of capital.

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