1．Loretta Lunn is an equity portfolio manager for Hardacre Softland Investments. She is considering acquiring a position in a chain of Internet cafés for her high-growth portfolio. Lunn considers the Internet café industry extremely attractive in the long term because of its potential for continuing global expansion. She believes the growing importance of the Internet will cause public access to computers to become ever more important to the economic development of emerging market nations. Lunn wants to be positioned for the eventual emergence of Internet cafés as necessary global infrastructure, along with railroads, telephones, and electricity.

Lunn is looking at two different Internet providers with established chains of Internet cafés. The first, FarTravel Technologies, is based in California and runs a chain of Internet cafes throughout North America and the Pacific Rim nations. The second, Alwaysnear Cafés, is based in Boston and has expanded throughout the Americas and into Europe.

Lunn has collected selected financial information on both companies:

Table 1: FarTravel vs. Alwaysnear Financial Data
(Dollars per share)

Lunn has asked the firm’s equity research analyst in the software space, Maura Mahoney, to provide some perspective on the two firms. Lunn plans to perform a residual income valuation on the two firms, and wants Mahoney’s perspective on the issues involved.

Mahoney is concerned about various accounting practices at the two firms. She points out to Lunn, “FarTravel’s management manipulate earnings by adjusting their allowance for bad debts. The company has essentially no bad debt historically because nearly all their transactions are in cash, but they continue to charge an allowance for bad debt against the income statement in order to smooth earnings. Before you analyze FarTravel, you need to adjust their allowance for bad debt to reflect a more realistic expected loss experience.”

Mahoney also points out that FarTravel has made enormous capital expenditures in the past few years to fund its rapid growth, creating a variety of accounting issues in its financial statements. The firm has entered into a significant number of material leases to provide hardware for its cafes, and set up several special purpose entities (SPEs) for similar purposes. Even with such off balance sheet financing, the firm has made enormous direct capital investments that have created substantial deferred tax liabilities. Mahoney advises Lunn, “If you use the residual income method, you don’t need to adjust for the firm’s lease obligations because they’re operating leases.”

Lunn remains concerned about the financial statement distortions at FarTravel. Lunn replies, “I do need to consolidate the SPEs before I perform a residual income valuation.” Mahoney adds, “You also need to eliminate the deferred tax liabilities and report them as equity since they are very likely to reverse.”

Similar issues exist at Alwaysnear. They have made several acquisitions across Europe as part of their growth strategy, and show substantial goodwill on their balance sheet. In addition, they use FIFO to account for inventory in order to maximize their reported net income. Mahoney considers that the use of FIFO by Alwaysnear represents a distortion in their financial statements. She counsels Lunn, “You need to put Alwaysnear on a LIFO basis before you do a residual income valuation.” For her part, Lunn is concerned about the valuation of goodwill. “I also need to exclude goodwill from the calculation of the book value of equity” she tells Mahoney.

Mahoney tells Lunn, “Once you have made the appropriate accounting adjustments, there are three steps to calculating residual income using a multi-stage model:

Regarding her statements about adjusting for FarTravel’s operating leases and bad debt allowance, is Mahoney correct or incorrect?

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A)              Incorrect                                 Incorrect

B)             Correct                                    Incorrect

C)             Correct                                     Correct

D)              Incorrect                                  Correct

2．The per share figures for intrinsic value and present value of expected economic profit for Alwaysnear are closest to:

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A)                $28.80                                $10.80

B)                $18.00                                $10.80

C)                $28.80                                $18.00

D)                $10.80                                $18.00

3．Regarding the statements about adjusting for FarTravel’s deferred tax liabilities and SPEs, who is correct?

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A)                Incorrect                                   Incorrect

B)                Correct                                     Incorrect

C)                Correct                                     Correct

D)                 Incorrect                                  Correct

4．Regarding Mahoney’s description of the three steps involved in performing a multi-stage residual income valuation, Mahoney is:

A)   correct about all three steps.

B)   correct about the first and second steps but incorrect about the third.

C)   correct about the second and third steps but incorrect about the first.

D)   correct about the first and last steps but incorrect about the second.

5．Regarding the statements about adjusting for FarTravel’s goodwill and inventory method, who is incorrect?

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A)                   Incorrect                                Correct

B)                   Incorrect                               Incorrect

C)                    Correct                                Incorrect

D)                    Correct                                  Correct

6．Which of the following statements about violations of the clean surplus relationship is the least accurate?

A)   The minimum liability adjustment in pension accounting may result in a violation of the clean surplus relationship.

B)   The ROE forecast will not be accurate if the clean surplus violations are not expected to offset in future years.

C)   Changes in market value of securities classified as available for sale may result in a violation of the clean surplus relationship.

D)   Net income is correct but book value needs to be adjusted.

答案和详解如下：

1．Loretta Lunn is an equity portfolio manager for Hardacre Softland Investments. She is considering acquiring a position in a chain of Internet cafés for her high-growth portfolio. Lunn considers the Internet café industry extremely attractive in the long term because of its potential for continuing global expansion. She believes the growing importance of the Internet will cause public access to computers to become ever more important to the economic development of emerging market nations. Lunn wants to be positioned for the eventual emergence of Internet cafés as necessary global infrastructure, along with railroads, telephones, and electricity.

Lunn is looking at two different Internet providers with established chains of Internet cafés. The first, FarTravel Technologies, is based in California and runs a chain of Internet cafes throughout North America and the Pacific Rim nations. The second, Alwaysnear Cafés, is based in Boston and has expanded throughout the Americas and into Europe.

Lunn has collected selected financial information on both companies:

Table 1: FarTravel vs. Alwaysnear Financial Data
(Dollars per share)

	FarTravel	Alwaysnear
Book value	$22	$18
ROE	23%	20%
Dividend payout ratio	10%	40%
Required rate of return on equity	19%	17%

Lunn has asked the firm’s equity research analyst in the software space, Maura Mahoney, to provide some perspective on the two firms. Lunn plans to perform a residual income valuation on the two firms, and wants Mahoney’s perspective on the issues involved.

Mahoney is concerned about various accounting practices at the two firms. She points out to Lunn, “FarTravel’s management manipulate earnings by adjusting their allowance for bad debts. The company has essentially no bad debt historically because nearly all their transactions are in cash, but they continue to charge an allowance for bad debt against the income statement in order to smooth earnings. Before you analyze FarTravel, you need to adjust their allowance for bad debt to reflect a more realistic expected loss experience.”

Mahoney also points out that FarTravel has made enormous capital expenditures in the past few years to fund its rapid growth, creating a variety of accounting issues in its financial statements. The firm has entered into a significant number of material leases to provide hardware for its cafes, and set up several special purpose entities (SPEs) for similar purposes. Even with such off balance sheet financing, the firm has made enormous direct capital investments that have created substantial deferred tax liabilities. Mahoney advises Lunn, “If you use the residual income method, you don’t need to adjust for the firm’s lease obligations because they’re operating leases.”

Lunn remains concerned about the financial statement distortions at FarTravel. Lunn replies, “I do need to consolidate the SPEs before I perform a residual income valuation.” Mahoney adds, “You also need to eliminate the deferred tax liabilities and report them as equity since they are very likely to reverse.”

Similar issues exist at Alwaysnear. They have made several acquisitions across Europe as part of their growth strategy, and show substantial goodwill on their balance sheet. In addition, they use FIFO to account for inventory in order to maximize their reported net income. Mahoney considers that the use of FIFO by Alwaysnear represents a distortion in their financial statements. She counsels Lunn, “You need to put Alwaysnear on a LIFO basis before you do a residual income valuation.” For her part, Lunn is concerned about the valuation of goodwill. “I also need to exclude goodwill from the calculation of the book value of equity” she tells Mahoney.

Mahoney tells Lunn, “Once you have made the appropriate accounting adjustments, there are three steps to calculating residual income using a multi-stage model:

Step #1:	Calculate the current book value per share.
Step #2:	Calculate residual income each year during the interim high-growth period and discount them back to their present value using the weighted average cost of capital (WACC).
Step #3:	Calculate continuing residual income at the end of the high-growth period using one of four approaches and then calculate its present value.”

Regarding her statements about adjusting for FarTravel’s operating leases and bad debt allowance, is Mahoney correct or incorrect?

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Operating leases

Bad debt allowance

A)         Incorrect                                 Incorrect

B)         Correct                                    Incorrect

C)         Correct                                   Correct

D)         Incorrect                               Correct

The correct answer was D)

Mahoney is incorrect that operating leases do not need to be adjusted in the residual value method. Operating leases should be capitalized by the present value of the expected future operating lease obligations. Mahoney is correct that the bad debt allowance should be adjusted to reflect expected loss experience.

2．The per share figures for intrinsic value and present value of expected economic profit for Alwaysnear are closest to:

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Intrinsic value

Economic profit

A)        $28.80                                $10.80

B)        $18.00                                  $10.80

C)        $28.80                                  $18.00

D)        $10.80                                  $18.00

The correct answer was A)

First we calculate g = ROE × retention ratio = 20% × (1 – 0.4) = 12%. Then we can calculate intrinsic value and economic profit:

V₀ = book value + (((ROE – r) × book value) / (r–g))
V₀ = $18 + (((0.20 – 0.17) × $18) / (0.17 – 0.12))
V₀ = $18 + ((0.03 × $18) / 0.05)
V₀ = $18 + (0.54 / 0.05)
V₀ = $18 + $10.80
V₀ = $28.80

The intrinsic value of the firm is $28.80, of which $10.80 is the present value of the expected economic profit.

3．Regarding the statements about adjusting for FarTravel’s deferred tax liabilities and SPEs, who is correct?

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Mahoney

Lunn

A)                Incorrect                                   Incorrect

B)                Correct                                     Incorrect

C)                Correct                                     Correct

D)                Incorrect                                    Correct

The correct answer was D)

Mahoney is incorrect. Deferred tax liabilities should be eliminated and reported as equity if they are unlikely, not likely, to reverse. Lunn is correct that SPEs should be eliminated and reported as equity.

4．Regarding Mahoney’s description of the three steps involved in performing a multi-stage residual income valuation, Mahoney is:

A)   correct about all three steps.

B)   correct about the first and second steps but incorrect about the third.

C)   correct about the second and third steps but incorrect about the first.

D)   correct about the first and last steps but incorrect about the second.

The correct answer was D)

Mahoney is incorrect about the second step because the discount rate used should be the required rate of return on equity, not the WACC. She is correct about the first and third steps.

5．Regarding the statements about adjusting for FarTravel’s goodwill and inventory method, who is incorrect?

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Mahoney

Lunn

A)              Incorrect                                   Correct

B)              Incorrect                                  Incorrect

C)              Correct                                    Incorrect

D)              Correct                                    Correct

The correct answer was B)

Mahoney and Lunn are both incorrect. In performing a residual income valuation, goodwill should not be excluded from the calculation of book value, and inventories for companies that use LIFO should be put on a FIFO basis.

6．Which of the following statements about violations of the clean surplus relationship is the least accurate?

A)   The minimum liability adjustment in pension accounting may result in a violation of the clean surplus relationship.

B)   The ROE forecast will not be accurate if the clean surplus violations are not expected to offset in future years.

C)   Changes in market value of securities classified as available for sale may result in a violation of the clean surplus relationship.

D)   Net income is correct but book value needs to be adjusted.

The correct answer was D)

Net income needs to be adjusted but book value is still correct.