Final answer:
Pro forma earnings are projections based on management's assumptions of future permanent earnings, crucial for forecasting a company's financial performance and influencing its stock price. These projections are distinct from historical financial reports and involve comprehensive future-oriented analysis that include explicit and implicit costs.
Step-by-step explanation:
Pro forma earnings refer to a company's earnings that are calculated based on management's assumptions about future events. The correct answer to the question 'Pro forma earnings are calculated' is (a) based on management's assumptions of permanent earnings. Pro forma earnings are used as a projection tool to forecast future financial performance and are not based on historical costs, statistical analysis, or assets to be converted to cash within an operating cycle. The discussion about stock prices being based on expectations about the future rather than current earnings ties closely into the concept of pro forma earnings. It emphasizes the importance of future performance and expectations, which pro forma earnings aim to quantify. Expectations can heavily influence stock prices, with shifts in these expectations causing changes in the market value of a company, aligning with the core principle of pro forma earnings which is to project future performance. Understanding the difference between accounting profit and economic profit is also crucial in business. Accounting profit accounts for explicit costs only, while economic profit takes into consideration both explicit and implicit costs. When analyzing the potential for future profits, considering the present discounted value of these profits is essential, as illustrated in the provided formulas for calculating this value.