Q11. Which of the following is least likely to characterize the difference between a residual income model and a FCFE model?

A)   A residual income model is applicable to a firm that does not have FCF.

B)   Terminal value represents a higher proportion of intrinsic value in a residual income model than in a dividend discount model (DDM).

C)   Inputs to a residual income model are more easily manipulated by management.

Q12. The residual income of Geremiah Analytics is closest to:

A)   $120,000.

B)   ?$120,000.

C)   $1,080,000.

Q13. Regarding their statements about ROE and residual income, who is correct?

          LaMarre                                Hofstedt

A)  Correct                                   Incorrect

B)  Correct                                   Correct

C)  Incorrect                                 Correct

Q14. 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%. What is Travel Advisors’ residual income?

A)   A loss of $31.8 million.

B)   A profit of $70.2 million.

C)   A profit of $31.8 million.

Q15. 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)   profit of $70.2 million.

B)   loss of $70.2 million.

C)   loss of $7.8 million.

Q16. Residual income is defined as:

A)   operating income plus depreciation and amortization.

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

C)   net income less a charge for capital investment.

Q11. Which of the following is least likely to characterize the difference between a residual income model and a FCFE model? fficeffice" />

A)   A residual income model is applicable to a firm that does not have FCF.

B)   Terminal value represents a higher proportion of intrinsic value in a residual income model than in a dividend discount model (DDM).

C)   Inputs to a residual income model are more easily manipulated by management.

Correct answer is B)

Terminal value represents a lower, not higher, proportion of intrinsic value in a residual income model than in other present value based approaches. A residual income model is applicable to a firm that does not have FCF and relies on accounting data that is generally easily found. However, the accounting data used in a residual income model are more easily manipulated by management than cash flow data. (Study Session 12, LOS 45.j)

Q12. The residual income of Geremiah Analytics is closest to:

A)   $120,000.

B)   ?$120,000.

C)   $1,080,000.

Correct answer is B)

Geremiah’s after-tax income is ($3 × (1 ? 0.40)) = $1.8 million. They have ($40 × 0.60) = $24 million in debt and ($40 × (1 ? 0.60)) = $16 million in equity. Their equity charge is ($16 × 0.12) = $1.92 million. Their residual income is ($1.8 × $1.92) = ?$0.12 million, or ?$120,000. (Study Session 12, LOS 45.a)

Q13. Regarding their statements about ROE and residual income, who is correct?

          LaMarre                                Hofstedt

A)  Correct                                   Incorrect

B)  Correct                                   Correct

C)  Incorrect                                 Correct

Correct answer is C)

LaMarre is incorrect because the present value of the continuing residual income for a firm is equal to the current value divided by the return on equity when residual income continues indefinitely, which is not the case if ROE declines to the return on equity capital. Hofstedt is correct that ROE declining to the cost of equity capital implies a decline in residual income and thus a persistence factor between zero and one. (Study Session 12, LOS 45.a, h)

Q14. 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%. What is Travel Advisors’ residual income?

A)   A loss of $31.8 million.

B)   A profit of $70.2 million.

C)   A profit of $31.8 million.

Correct answer is A)

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.

Q15. 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)   profit of $70.2 million.

B)   loss of $70.2 million.

C)   loss of $7.8 million.

Correct answer is C)

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.

Q16. Residual income is defined as:

A)   operating income plus depreciation and amortization.

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

C)   net income less a charge for capital investment.

Correct answer is B)

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

thanks