Question #24
Reading: Reading 23 Residual Income Valuation
PDF File: Reading 23 Residual Income Valuation.pdf
Page: 11
Status: Correct
Correct Answer: A
Question
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:
Answer Choices:
A. – $128,369,000
B. – $128,420,000
C. – $128,471,000
Explanation
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