Reading 43: Residual Income Valuation-LOS a, (Part 1) 习题精 2010, class, assets, software, interpret

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Session 12: Equity Investments: Valuation Models
Reading 43: Residual Income Valuation

LOS a, (Part 1): Calculate and interpret residual income.

 

 

 

Cognitive Products (CP) designs decision-making software. The book value of its assets is $3.2 billion, which is financed with $2.0 billion in equity and $1.2 billion in debt. Its before-tax cost of debt is 6.5%, while its relevant tax rate is 34%. CP has a cost of equity of 12.46%. Its abbreviated income statement is:

Earnings before interest and taxes (EBIT)	$213,000,000
Interest expense	(30,000,000)
Pretax income	183,000,000
Income tax expense	(62,220,000)
Net income	$120,780,000

The residual income (RI) for CP is closest to:

A) –$128,471,000.

B) –$128,420,000.

C) –$128,369,000.

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The dollar-based equity charge is:

equity charge = equity capital × cost of equity = $2.0 billion × 0.1246 = $249,200,000.

RI is calculated as:

Net Income	$120,780,000
(Less) Equity charge	(249,200,000)
RI	?$128,420,000

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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 profit of $70.2 million.

B) A loss of $31.8 million.

C) A profit of $31.8 million.

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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.

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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.

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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.

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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.

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