America Online, Inc.

Questions for Students The following questions will guide you through the material. 1. Prior to 1995, why was AOL so successful in the commercial online industry relative to its competitors CompuServe and Prodigy? 2. As of 1995, what are the key changes taking place in the commercial online industry? How are they likely to affect AOL’s future prospects? 3. Was AOL’s policy to capitalize subscriber acquisition costs justified prior to 1995? 4. Given the changes discussed in question 2, do you think AOL should change its accounting policy as of 1995? Is the company’s response consistent with your view? 5. What would be the affect on AOL’s 1995 balance sheet if all the capitalized subscriber acquisition costs were written off? If AOL expensed all the subscriber acquisition costs incurred in fiscal 1995 during the same year, what would be the effect on its income statement? 6. AOL’s share price as of November 8, 1995 was $81.63. In October 1995, the company issued $100 million worth of new shares (1.713 million shares at $58.73 dollars per share). Its book value as of June 30, 1995 was $217.944 million. Assuming that there is no change in AOL’s book value other than that due to the new share issue, compute AOL’s market to book ratio as of November 8, 1995. 7. Assuming a perpetual average growth rate in book value of 15% per year, calculate the longrun average return on equity needed to be earned by AOL to justify its market to book ratio as of November 8, 1995. 8. Based on your analysis in questions 1-5, do you think that the return on equity and growth rate assumptions implied by AOL’s market to book ratio are realistic?

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