Lorenz Kummert is a junior equity analyst who is following Schubert, Inc. (Schubert), a small publicly traded company in the United States. His supervisor, Markus Alter, CFA, has advised him to use the residual income model to analyze Schubert.In his preliminary report to Alter, Kummert makes the following statements:Statement 1: Residual income models are appropriate when expected free cash flows are negative for the foreseeable future.Statement 2: Residual income models are not applicable when cash flows are volatile.Kummert has determined Schubert's cost of equity, cost of debt, and weighted average cost of capital (WACC) to be 12.8%, 8.4%, and 11.9%, respectively. The current price of the stock is $35 per share and there are 130,000 shares outstanding. The relevant tax rate is 30%, and return on equity (ROE) is expected to be 13%.Summarized financial information about Schubert for 2008 is provided in Exhibits I and II.Based on his analysis of several years of financial statements, Kummert notes that 2008 was an exceptionally profitable year for Schubert, and that its dividend payouts are usually low because the funds are mainly reinvested in the firm to promote growth. Furthermore, there are very few nonrecurring items on the income statement. Upon review of Kummert's preliminary report, Alter concurs with his analysis of the financial statements but reminds him that Schubert's long-term debt is currently trading at 95% of its book value. He also cautions Kummert that violations of the clean surplus relation can bias the results of the residual income model.The consensus annual EPS estimate for 2009 is $6.15, and the dividend payout ratio for 2009 is estimated at 5%.Are Kummert's statements regarding the residual income model correct?
Answer(s): B
Residual income models are appropriate when expected free cash flows are negative for the foreseeable future.Residual income models are applicable even when cash flows arc volatile. (Study Session 12, LOS 43.h,n,o)
Lorenz Kummert is a junior equity analyst who is following Schubert, Inc. (Schubert), a small publicly traded company in the United States. His supervisor, Markus Alter, CFA, has advised him to use the residual income model to analyze Schubert.In his preliminary report to Alter, Kummert makes the following statements:Statement 1: Residual income models are appropriate when expected free cash flows are negative for the foreseeable future.Statement 2: Residual income models are not applicable when cash flows are volatile.Kummert has determined Schubert's cost of equity, cost of debt, and weighted average cost of capital (WACC) to be 12.8%, 8.4%, and 11.9%, respectively. The current price of the stock is $35 per share and there are 130,000 shares outstanding. The relevant tax rate is 30%, and return on equity (ROE) is expected to be 13%.Summarized financial information about Schubert for 2008 is provided in Exhibits I and II.Based on his analysis of several years of financial statements, Kummert notes that 2008 was an exceptionally profitable year for Schubert, and that its dividend payouts are usually low because the funds are mainly reinvested in the firm to promote growth. Furthermore, there are very few nonrecurring items on the income statement. Upon review of Kummert's preliminary report, Alter concurs with his analysis of the financial statements but reminds him that Schubert's long-term debt is currently trading at 95% of its book value. He also cautions Kummert that violations of the clean surplus relation can bias the results of the residual income model.The consensus annual EPS estimate for 2009 is $6.15, and the dividend payout ratio for 2009 is estimated at 5%.Assuming that Kummert and Alter are correct with their conclusions regarding Schubert's financial statements, which of the following levels would best describe the strength of the persistence factor with respect to Schubert's residual income?
Answer(s): C
A high persistence factor will be associated with low dividend payments, which is exactly the case with Schubert.A low persistence factor will be associated with significant levels of nonrecurring items. However, Schubert has very few nonrecurring items (which would suggest a high persistence factor). (Study Session 12, LOS 43-h)
Lorenz Kummert is a junior equity analyst who is following Schubert, Inc. (Schubert), a small publicly traded company in the United States. His supervisor, Markus Alter, CFA, has advised him to use the residual income model to analyze Schubert.In his preliminary report to Alter, Kummert makes the following statements:Statement 1: Residual income models are appropriate when expected free cash flows are negative for the foreseeable future.Statement 2: Residual income models are not applicable when cash flows are volatile.Kummert has determined Schubert's cost of equity, cost of debt, and weighted average cost of capital (WACC) to be 12.8%, 8.4%, and 11.9%, respectively. The current price of the stock is $35 per share and there are 130,000 shares outstanding. The relevant tax rate is 30%, and return on equity (ROE) is expected to be 13%.Summarized financial information about Schubert for 2008 is provided in Exhibits I and II.Based on his analysis of several years of financial statements, Kummert notes that 2008 was an exceptionally profitable year for Schubert, and that its dividend payouts are usually low because the funds are mainly reinvested in the firm to promote growth. Furthermore, there are very few nonrecurring items on the income statement. Upon review of Kummert's preliminary report, Alter concurs with his analysis of the financial statements but reminds him that Schubert's long-term debt is currently trading at 95% of its book value. He also cautions Kummert that violations of the clean surplus relation can bias the results of the residual income model.The consensus annual EPS estimate for 2009 is $6.15, and the dividend payout ratio for 2009 is estimated at 5%.Which of the following amounts is closest to the forecast of Schubert's book value per share and residual income, respectively, for 2009?Book value per share Residual income
Answer(s): A
Lorenz Kummert is a junior equity analyst who is following Schubert, Inc. (Schubert), a small publicly traded company in the United States. His supervisor, Markus Alter, CFA, has advised him to use the residual income model to analyze Schubert.In his preliminary report to Alter, Kummert makes the following statements:Statement 1: Residual income models are appropriate when expected free cash flows are negative for the foreseeable future.Statement 2: Residual income models are not applicable when cash flows are volatile.Kummert has determined Schubert's cost of equity, cost of debt, and weighted average cost of capital (WACC) to be 12.8%, 8.4%, and 11.9%, respectively. The current price of the stock is $35 per share and there are 130,000 shares outstanding. The relevant tax rate is 30%, and return on equity (ROE) is expected to be 13%.Summarized financial information about Schubert for 2008 is provided in Exhibits I and II.Based on his analysis of several years of financial statements, Kummert notes that 2008 was an exceptionally profitable year for Schubert, and that its dividend payouts are usually low because the funds are mainly reinvested in the firm to promote growth. Furthermore, there are very few nonrecurring items on the income statement. Upon review of Kummert's preliminary report, Alter concurs with his analysis of the financial statements but reminds him that Schubert's long-term debt is currently trading at 95% of its book value. He also cautions Kummert that violations of the clean surplus relation can bias the results of the residual income model.The consensus annual EPS estimate for 2009 is $6.15, and the dividend payout ratio for 2009 is estimated at 5%.Which of the following amounts are closest to the economic value added (EVA) and market value added (MVA) of Schubert, respectively?EVA MVA
Economic value added (EVA) is calculated as follows:$WACC = WACC x invested capitalNote that invested capital = net working capital + net fixed assets OR book value of long-term debt + book value of equity= 0.119 x ($6,211,000 + $2,100,000 4 $2,081,000) = $1,236,648 EVA = NOPAT - $WACC= EBIT(1 -t)-$WACC= $1,868,000(1 - 0.30) - $1,236,648= $70,952Market value of the company = market value of the equity + market value of the debt= ($35 x 130,000) + (0.95 x 6,211,000)= $10,450,450Market value added (MVA) = market value - invested capital=$10,450,450 - ($6,211,000 + $2,100,000 * $2,081,000) = $58,450(Study Session 12, LOS 43.a)
Lorenz Kummert is a junior equity analyst who is following Schubert, Inc. (Schubert), a small publicly traded company in the United States. His supervisor, Markus Alter, CFA, has advised him to use the residual income model to analyze Schubert.In his preliminary report to Alter, Kummert makes the following statements:Statement 1: Residual income models are appropriate when expected free cash flows are negative for the foreseeable future.Statement 2: Residual income models are not applicable when cash flows are volatile.Kummert has determined Schubert's cost of equity, cost of debt, and weighted average cost of capital (WACC) to be 12.8%, 8.4%, and 11.9%, respectively. The current price of the stock is $35 per share and there are 130,000 shares outstanding. The relevant tax rate is 30%, and return on equity (ROE) is expected to be 13%.Summarized financial information about Schubert for 2008 is provided in Exhibits I and II.Based on his analysis of several years of financial statements, Kummert notes that 2008 was an exceptionally profitable year for Schubert, and that its dividend payouts are usually low because the funds are mainly reinvested in the firm to promote growth. Furthermore, there are very few nonrecurring items on the income statement. Upon review of Kummert's preliminary report, Alter concurs with his analysis of the financial statements but reminds him that Schubert's long-term debt is currently trading at 95% of its book value. He also cautions Kummert that violations of the clean surplus relation can bias the results of the residual income model.The consensus annual EPS estimate for 2009 is $6.15, and the dividend payout ratio for 2009 is estimated at 5%.Which of the following amounts is closest to Schubert's implied growth rate in residual income?
g=r- = [(2,100,000 + 2,081,000)] / 130,000 = $32.16r = cost of equity = 12.8%g = 0.128 – = 0.1053= 10.53%(Study Session 12, LOS 43.g)
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