Residual income question

accounting, question, interest, someone

According to V4, p. 598 of the CFAI text, a drawback of the residual income model is that
“The RIM’s use of accounting income assumes that the cost of debt is reflected appropriately by interest expense.”
I’m a little lost on that one - can someone flesh it out for me? Thanks.

brainsX

CFA Candidates

Rank: 2

UID: 223405
帖子: 284
主题: 9
注册时间: 2011-7-11
最后登录: 2014-7-31

2^#

发表于 2013-4-1 13:19 | 只看该作者

you assume debtholder’s (or any interest-bearing securities senior to common stock) are paid what they are owed, timely interest etc. this interest should be reflected in the interest expense…to make it more complicated, we hope lease expense when capitalized is appropriated to interest if NOT then the cost of debt is not accurate and the residual income is not correct..(i include leases as debt bc they are senior to common stock in bankruptcy)

TOP

badonkus

CFA Candidates

Rank: 2

UID: 223389
帖子: 274
主题: 59
注册时间: 2011-7-11
最后登录: 2016-4-15

3^#

发表于 2013-4-1 13:19 | 只看该作者

Residual Income could also be calculated using NOPAT - WACC$
I guess using accounting income assumes that the debt portion of the WACC$ is the same as interest…If interest expense is the true cost of debt then these two methods will give the same answer.

TOP

YAhmed