1.Residual income is defined as:

A)   net income less a charge for capital investment.

B)   net income less a charge that measures stockholders' opportunity cost in generating that income.

C)   net income plus non-cash charges.

D)   operating income plus depreciation and amortization.

2.Travel Advisors has earnings before interest and taxes (EBIT) of $200 million, interest expense of $83 million, taxes of $46.8 million, and total debt of $125 million. It is also financed with total equity of $650 million, which has a required rate of return of 12 percent. What is Travel Advisors’ residual income? A:

A)   loss of $70.2 million.

B)   profit of $70.2 million.

C)   profit of $7.8 million.

D)   loss of $7.8 million.

3.Travel Advisors has earnings before interest and taxes (EBIT) of $200 million, interest expense of $83 million, taxes of $46.8 million, and total debt of $125 million. It is also financed with total equity of $850 million, which has a required rate of return of 12 percent. What is Travel Advisors’ residual income? A:

A)   profit of 31.8 million.

B)   profit of $70.2 million.

C)   loss of $31.8 million.

D)   loss of $70.2 million.

4.Geremiah Analytics provides litigation consulting services to the intellectual property industry. They specialize in patent infringement liability and software valuation. Mariah Hofstedt, CFO of Geremiah, projects that the firm will earn $3 million pre-tax income this year. Additional selected financial data on Geremiah are presented below.

Table 1: Selected Financial Data for Geremiah Analytics

Hofstedt has not been happy with the firm’s financial performance. She would like to increase return on equity (ROE) and improve revenue growth, and is considering various ways to deploy Geremiah’s cash flow in order to meet these two goals. One possibility is using some of Geremiah’s cash flow to make a strategic acquisition.

Hofstedt has been looking at a smaller boutique firm, Logiciels LaMarre, which provides consulting services to the software industry. Hofstedt and a Geremiah Analytics valuation team have performed a preliminary valuation on Logiciels LaMarre using a free cash flow to equity model. However, Theodore LaMarre, CEO of Logiciels LaMarre, is not pleased with the resultant valuation that Geremiah has placed on his firm.

Rather than argue about the inputs of the free cash flow model, LaMarre takes the position that free cash flow to equity is an inappropriate model for valuing Logiciels LaMarre. He cites the firm’s rapid growth and resultant need for capital investment as reasons that valuing the firm on projections of free cash flow to equity is not reliable.

LaMarre wants Geremiah to value Logiciels LaMarre using the residual income approach. LaMarre tells Hofstedt, “Valuation with residual income models is less sensitive to forecast error than valuation with free cash flow to equity models because residual income valuations rely on current book value.”

Hofstedt feels substantial disagreement with LaMarre’s approach on a variety of grounds. She views his arguments as negotiating ploys to raise the acquisition price of his firm, and does not agree with his assessment of the free cash flow valuation her team has developed. On a theoretical basis, Hofstedt considers the residual income approach an inappropriate tool for valuing a firm like Logiciels LaMarre. Hofstedt tells LaMarre, “It’s not appropriate to use a residual income model to value Logiciels LaMarre because the impact of your currency translation gains and losses in shareholder equity causes the clean surplus accounting relation to be violated.”

LaMarre ignores her concern and persists in his argument. He asserts, “The fact that our terminal value can be calculated with a high degree of certainty makes the use of a residual value model more appropriate than use of a free cash flow to equity model.” Hofstedt counters that the residual income approach is not in LaMarre’s interest. She points out, “Value tends to be recognized later in a residual income approach than in a free cash flow to equity approach.”

There is, however, one point on which LaMarre and Hofstedt agree. They both recognize that competitive forces in the industry will drive the current high ROE of Logiciels LaMarre down to the cost of equity capital over time. Hofstedt concludes, “Given the assumption of a decline in ROE, we should use a persistence factor between zero and one.” LaMarre disagrees, saying, “The assumption about ROE means that the present value of the continuing residual income at Logiciels LaMarre is the current residual income divided by the cost of equity capital.”

Regarding their statements about the impact of the clean surplus accounting relation and terminal value on when it is appropriate to use a residual income model, who is correct?

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A)                   Correct                                  Correct

B)                   Incorrect                                Correct

C)                  Correct                                  Incorrect

D)                  Incorrect                                Incorrect

5.A higher dividend payout ratio and higher return on equity (ROE) would most likely have what impact on Logiciels LaMarre’s persistence factor?

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A)                      Lower                                  Lower

B)                      Lower                                  Higher

C)                      Higher                                  Lower

D)                      Higher                                  Higher

答案和详解如下：

1.Residual income is defined as:

A)   net income less a charge for capital investment.

B)   net income less a charge that measures stockholders' opportunity cost in generating that income.

C)   net income plus non-cash charges.

D)   operating income plus depreciation and amortization.

The correct answer was B)

Residual income is defined as net income less a charge that measures stockholders’ opportunity cost in generating that income.

2.Travel Advisors has earnings before interest and taxes (EBIT) of $200 million, interest expense of $83 million, taxes of $46.8 million, and total debt of $125 million. It is also financed with total equity of $650 million, which has a required rate of return of 12 percent. What is Travel Advisors’ residual income? A:

A)   loss of $70.2 million.

B)   profit of $70.2 million.

C)   profit of $7.8 million.

D)   loss of $7.8 million.

The correct answer was D)

Net income = 200,000,000 – 83,000,000 – 46,800,000 = $70,200,000. The equity capital charge is 650,000,000 × 0.12 = $78,000,000. Thus, residual income = 70,200,000 – 78,000,000 = –$7,800,000.

3.Travel Advisors has earnings before interest and taxes (EBIT) of $200 million, interest expense of $83 million, taxes of $46.8 million, and total debt of $125 million. It is also financed with total equity of $850 million, which has a required rate of return of 12 percent. What is Travel Advisors’ residual income? A:

A)   profit of 31.8 million.

B)   profit of $70.2 million.

C)   loss of $31.8 million.

D)   loss of $70.2 million.

The correct answer was C)

Net income = 200,000,000 – 83,000,000 – 46,800,000 = $70,200,000. The equity capital charge is 850,000,000 × 0.12 = $102,000,000. Thus, residual income = 70,200,000 – 102,000,000 = –$31,800,000.

4.Geremiah Analytics provides litigation consulting services to the intellectual property industry. They specialize in patent infringement liability and software valuation. Mariah Hofstedt, CFO of Geremiah, projects that the firm will earn $3 million pre-tax income this year. Additional selected financial data on Geremiah are presented below.

Table 1: Selected Financial Data for Geremiah Analytics

Total assets	$40 million
Debt/assets	60%
Average coupon on debt	8%
Cost of equity	12%
Tax rate	40%

Hofstedt has not been happy with the firm’s financial performance. She would like to increase return on equity (ROE) and improve revenue growth, and is considering various ways to deploy Geremiah’s cash flow in order to meet these two goals. One possibility is using some of Geremiah’s cash flow to make a strategic acquisition.

Hofstedt has been looking at a smaller boutique firm, Logiciels LaMarre, which provides consulting services to the software industry. Hofstedt and a Geremiah Analytics valuation team have performed a preliminary valuation on Logiciels LaMarre using a free cash flow to equity model. However, Theodore LaMarre, CEO of Logiciels LaMarre, is not pleased with the resultant valuation that Geremiah has placed on his firm.

Rather than argue about the inputs of the free cash flow model, LaMarre takes the position that free cash flow to equity is an inappropriate model for valuing Logiciels LaMarre. He cites the firm’s rapid growth and resultant need for capital investment as reasons that valuing the firm on projections of free cash flow to equity is not reliable.

LaMarre wants Geremiah to value Logiciels LaMarre using the residual income approach. LaMarre tells Hofstedt, “Valuation with residual income models is less sensitive to forecast error than valuation with free cash flow to equity models because residual income valuations rely on current book value.”

Hofstedt feels substantial disagreement with LaMarre’s approach on a variety of grounds. She views his arguments as negotiating ploys to raise the acquisition price of his firm, and does not agree with his assessment of the free cash flow valuation her team has developed. On a theoretical basis, Hofstedt considers the residual income approach an inappropriate tool for valuing a firm like Logiciels LaMarre. Hofstedt tells LaMarre, “It’s not appropriate to use a residual income model to value Logiciels LaMarre because the impact of your currency translation gains and losses in shareholder equity causes the clean surplus accounting relation to be violated.”

LaMarre ignores her concern and persists in his argument. He asserts, “The fact that our terminal value can be calculated with a high degree of certainty makes the use of a residual value model more appropriate than use of a free cash flow to equity model.” Hofstedt counters that the residual income approach is not in LaMarre’s interest. She points out, “Value tends to be recognized later in a residual income approach than in a free cash flow to equity approach.”

There is, however, one point on which LaMarre and Hofstedt agree. They both recognize that competitive forces in the industry will drive the current high ROE of Logiciels LaMarre down to the cost of equity capital over time. Hofstedt concludes, “Given the assumption of a decline in ROE, we should use a persistence factor between zero and one.” LaMarre disagrees, saying, “The assumption about ROE means that the present value of the continuing residual income at Logiciels LaMarre is the current residual income divided by the cost of equity capital.”

Regarding their statements about the impact of the clean surplus accounting relation and terminal value on when it is appropriate to use a residual income model, who is correct?

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LaMarre

Hofstedt

A)                 Correct                                  Correct

B)                 Incorrect                                 Correct

C)                 Correct                                  Incorrect

D)                 Incorrect                                Incorrect

The correct answer was B)

LaMarre is incorrect because residual income models are appropriate when terminal value is highly uncertain. Hofstedt is correct that a residual income approach is not appropriate if the clean surplus accounting relation is violated, for example by currency translation gains and losses going straight into equity.

5.A higher dividend payout ratio and higher return on equity (ROE) would most likely have what impact on Logiciels LaMarre’s persistence factor?

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ROE

Dividend payout ratio

A)                    Lower                                     Lower

B)                    Lower                                    Higher

C)                    Higher                                    Lower

D)                    Higher                                    Higher

The correct answer was A)

A higher persistence factor is associated with a low dividend payout ratio, and vice versa. A high return on equity is associated with a lower persistence factor.