http://www.analystforum.com/phorums/read.php?1,920196 I hate to admit it, but I’m getting a bit desperate. If any of you could help me along, I’d greatly appreciate it. Question 2 - 88597 Sue Clifton, CFA, is a senior portfolio manager at Lewiston Investments, a small research firm. Clifton has been assigned to help new hire Ralph Rawls get acclimated to his new job as a stock analyst. She discovers early on that Rawls is not too familiar with residual income valuation, a tool for determining economic profitability. Clifton explains the basics of the residual-income model and the clean surplus relationship that underpins the system. Clifton then offers Rawls some reasons why residual income is useful: Reason 1: “Residual-income valuation works even when cash flows are volatile or negative.” Reason 2: “Terminal value, the most uncertain aspect of dividend discount models, is less important in residual-income valuation.” Reason 3: “The models depend on data that is easy to obtain and requires minimal modification.” Reason 4: “All residual-income models are dependent on assumptions about earnings growth.” Clifton explains to Rawls that analysts use assumptions to make the residual-income models easier to interpret. She goes on to identify four commonly used assumptions: Residual income can be expected to: disappear immediately decline gradually as return on equity (ROE) declines stay at the same level indefinitely decline to the market average After her initial review of residual income, Clifton gives Rawls a test. The answers depend on the use of the following information about CR Industries in Year X (in $ millions): Invested capital $225 Market capitalization $231 Tax rate 40.0% Interest expense $12 Depreciation and amortization expense $25 Selling, general & administrative (SG&A) expense $10 Dividend expense $6 Debt $130 Cost of goods sold (COGS) $26 Sales $90 Pretax cost of equity 11.4% Pretax cost of debt 5.0% Part 1) When a company’s ROE is the same as the return required by the market, the stock’s justified market value is closest to the: A) actual market value plus residual income. B) book value plus residual income. C) book value. Part 2) Which of the following assumptions is not commonly used to simplify the calculation of residual income? Continuing residual income is expected to: A) decline gradually as ROE declines. B) disappear immediately. C) decline to the market average. Part 3) Which of the following regarding the statements Clifton made about the usefulness of residual-income valuation is most accurate? Clifton is correct in regard to: A) Reasons 1, 2, and 4, but incorrect in regard to Reason 3. B) Reason 4, but incorrect in regard to Reasons 1, 2 and 3. C) Reasons 1 and 2, but incorrect in regard to Reasons 3 and 4. Part 4) Which of the following scenarios represents a violation of the clean surplus relationship? A) The market value of securities held for sale changes. B) Unusual charges against income are not charged against equity. C) A company stops paying dividends suddenly. Part 5) The residual income of CR Industries is closest to: A) −$15.45 million. B) −$0.63 million. C) −$4.23 million. Part 6) The economic value added (EVA) of CR Industries is closest to: A) −$8.13 million. B) $2.66 million. C) −$4.53 million.
Q1.C? ROE = r 2nd term = 0 V0 = B0 + 2ndterm V0 = B0 Q2.C? nothing like C - but we have gradial decline to long term industry avg or something. decline gradually as ROE->r so 0
- C 2) B 3) C 4) A 5) A 6) B Really need to work on this section a lot it looks like. Struggling to remember what residual income actually is. If anyone wants to give a brief description it would be helpful… ditch, hope the hunt works out for you man. I wish i could help, but i work in a job where it isnt investment management related and even when i pass these stupid tests it will take 4 yrs to get a designation… just trying to pass to sneak my way into some type of investment job… Best of luck to you… you seem dedicated enough, so i think it will work out for you in the end…
Same here ditch, I don’t work in the industry at all else would have surely pulled strings for ya man!. The other job you talked of in the mail is too time consuming and I think after the tax-season you better buckle up for a 150mph ride for L2 man and then hit the school later-on. my 2-cents bro!
- C 2) C 3) C 4) A 5) B 6) C (guess. don’t remember the equation for EVA)
Thanks guys! When a company’s ROE is the same as the return required by the market, the stock’s justified market value is closest to the: A) actual market value plus residual income. B) book value plus residual income. C) book value. Your answer: C was correct! When ROE is equal to the required return on equity, the justified market value of a share of stock is equal to its book value. In this case, there is no residual income. (Study Session 12, LOS 45.a, b) -------------------------------------------------------------------------------- Which of the following assumptions is not commonly used to simplify the calculation of residual income? Continuing residual income is expected to: A) decline gradually as ROE declines. B) disappear immediately. C) decline to the market average. Your answer: B was incorrect. The correct answer was C) decline to the market average. A common assumption involves residual income declining to an average level consistent with a mature industry. This assumption makes sense, considering that we generally calculate residual income for an individual company, and the company’s industry average is quite possibly the best benchmark for its future income-generation potential. The market average is not generally used as a proxy. Both remaining assumptions are commonly used. (Study Session 12, LOS 45.a) -------------------------------------------------------------------------------- Which of the following regarding the statements Clifton made about the usefulness of residual-income valuation is most accurate? Clifton is correct in regard to: A) Reasons 1, 2, and 4, but incorrect in regard to Reason 3. B) Reason 4, but incorrect in regard to Reasons 1, 2 and 3. C) Reasons 1 and 2, but incorrect in regard to Reasons 3 and 4. Your answer: C was correct! Clifton’s Reasons 1 and 2 are correct. Residual-income models work when cash flows are volatile or negative and are not dominated by terminal value calculations. Clifton’s Reason 3 is incorrect. Residual-income models use accounting data that is easy to find, but often requires numerous adjustments. Reason 4 is also incorrect. General residual-income models make no assumptions in regard to future earnings growth. They can be modified to include growth if the dividend rate and the growth rate are assumed to be constant. (Study Session 12, LOS 45.a, c) -------------------------------------------------------------------------------- Which of the following scenarios represents a violation of the clean surplus relationship? A) The market value of securities held for sale changes. B) Unusual charges against income are not charged against equity. C) A company stops paying dividends suddenly. Your answer: A was correct! The clean surplus relationship holds that ending book value equals the beginning book value plus earnings minus dividends, excluding ownership transactions. The relationship is violated when charges skip the income statement and go directly to equity. Changes in the market value of debt and equity classified as available for sale can affect equity without affecting earnings. Unusual charges should not be included in residual-value calculations because they are not expected to recur. Charges that do not affect equity will not violate the relationship. Cessation of dividends also does not violate the relationship. (Study Session 12, LOS 45.m) -------------------------------------------------------------------------------- The residual income of CR Industries is closest to: A) −$15.45 million. B) −$0.63 million. C) −$4.23 million. Your answer: A was incorrect. The correct answer was B) −$0.63 million. Residual income = net income − equity charge. Net income = (sales − COGS − SG&A expense − depreciation and amortization expense − interest expense) × (1 − tax rate) = $10.2 million. Equity charge = equity × cost of equity. (total capital - debt) × cost of equity = $95 million × 11.4% = $10.83 million. Residual income = $10.2 million − $10.83 million = −$0.63 million. (Study Session 12, LOS 45.a) -------------------------------------------------------------------------------- The economic value added (EVA) of CR Industries is closest to: A) −$8.13 million. B) $2.66 million. C) −$4.53 million. Your answer: B was correct! EVA = NOPAT − (WACC × invested capital). NOPAT = (sales − COGS − SG&A expense − depreciation and amortization expense) × (1 − tax rate) = $17.40 million. To calculate the weighted average cost of capital (WACC), start by determining the percentage of equity and debt. $130 million in debt represented 57.78% of total capital. The remaining 42.22% is the equity portion. Don’t forget to adjust the cost of debt for taxes. WACC = 57.78% × (5% × [1 − 40%]) + (42.22% × 11.4%) = 6.55%. EVA = $17.40 million − ($225 million × 6.55%) = $2.66 million. (Study Session 12, LOS 45.a)
ditchdigger2CFA Wrote: ------------------------------------------------------- > http://www.analystforum.com/phorums/read.php?1,920 > 196 > > I hate to admit it, but I’m getting a bit > desperate. If any of you could help me along, I’d > greatly appreciate it. > > For those of you in the know, I’m moving on from my tax job on 4/15. I do have some unemployment compensation available, but honestly I feel awful just milking the system. I set off to find work and actually resorted to a skill I honed at 18 years old, and interviewed for a grounds/maintenance department of a private golf club. The grounds superintendent seemed a bit surprised when I showed up to interview in business casual since I scheduled the interview at 7am before my day job. Luckily, digging ditches and watering grass will not be my summer job. I snagged an internship at a small hedge fund run by an acquaintance of mine (Networking DOES pay!). Given the current state of the economy, the compensation will be quite low, but I feel the experience would be WELL worth it. This summer I will have three projects to complete/implement. 1. Make the fund marketable to institutional investors. To do this I will be implementing GIPS. 2. Find a database to place the fund in. I’ll have to break out my CAIA books since database identification was one of the Learning Objectives. 3. Implement monthly rather than quarterly reporting on the funds performance. I may need some help with the software/Excel plugs to do this. Ideally the PM wants performance, std deviation, variance, R squared, etc reported monthly. In his small shop of 4 people, they just do not have the means to get this out regularly. Automation would be ideal. Needless to say I’m VERY please with this opportunity vs the fall back job of cutting grass. Likewise seeing what is inside the black box will be interesting as well. His firm runs 4 portfolios, three were down only single digits in 08, and one was up single digits. So now I’m determined to pass Level 2. I’ll have 1.5 months away from work to do nothing but work out and study. It was very nice of the PM to give me the necessary time for this. This summer will now be one of WSP w/SwaptionG, leisurely reading, exercising, and working. Life is good!
Good job ditch. Congo! I am with you on the WSP
congrats ditch. now you have the time and the energy to keep those “lcs” in local currency coming!!!
how big is the fund AUM?
ps- i hear WSP, i think widespread panic. that’s the only WSP i want in my life.
I do not know the AUM at this time. I’ll be sure to let you know more later on. Thanks for all the wishes. Now I’m back to SS6.
bannisja Wrote: ------------------------------------------------------- > ps- i hear WSP, i think widespread panic. > that’s the only WSP i want in my life. WSP: Driving song!!
cool- as you get closer, feel free to hit me up offline… i work in the space and might be able to share a bit of wisdom. i’ll get back to ss12. ss6 and 12 really are the endless study sessions.
for what it’s worth - I have just studied 1 hour total today in bits and pieces of 15 mins each. I am at the peak of my saturation and just kept staring at the world outside, where people are enjoying as if there will be no tomorrow. What have I done to my life folks - I feel so depressed today!
swaptiongamma Wrote: ------------------------------------------------------- > for what it’s worth - I have just studied 1 hour > total today in bits and pieces of 15 mins each. I > am at the peak of my saturation and just kept > staring at the world outside, where people are > enjoying as if there will be no tomorrow. > > What have I done to my life folks - I feel so > depressed today! Time to hit the gym, SG. I went to class this morning with my spanish spin instructor and was at my max for a good bit. Energized me for the whole day.
office gym closed. And I have a spin class on monday 5.30 to 6.15. Before that need to do the regular run on the mill. I am really not able to look at the books today. Hopefully tomorrow night I should be back to studying man. Lot of time wasted today.
bannisja Wrote: ------------------------------------------------------- > cool- as you get closer, feel free to hit me up > offline… i work in the space and might be able > to share a bit of wisdom. i’ll get back to ss12. > ss6 and 12 really are the endless study sessions. I’ll do that.
All multiples of 6 (SS6,SS12, SS18) are ridiculously long.
nice observation about the multiplicative property of 6 you have noticed there. and 666 (remember Omen), it’s the devil incarnate…