CFA Practice Question

There are 201 practice questions for this study session.

CFA Practice Question

An analyst gathers the following data for a company (all data in $MM):

  • Total assets: $380.
  • Debt: $114.
  • Pretax cost of debt: 5%.
  • Equity (26.6 million shares outstanding): $266.
  • Cost of equity: 14%.
  • EBIT: $45.
  • Marginal tax rate: 40%

The residual income of the company using equity charge method is:
A. -$12.8.
B. -$10.4.
C. -$13.6.
Explanation: We calculate net income first:

Using the equity charge method, we calculate residual income:

Equity charge = Equity x cost of equity = $266 x 0.14 = $37.2.
Residual income = Net income - Equity charge = $(13.6)

User Contributed Comments 2

User Comment
americade The Capital Charge method results in the same Residual Income, I tried both methods.
b25331 A fast alternative method:
Calculate NOPAT: EBIT x (1-t) = 27
Divide NOPAT by TA: 27/380 = 7.11%
Calculate WACC: 10.70
Difference in returns: 7.11%-10.70% = -3.59%
Since NOPAT-to-Assets is lower than WACC, economic value is deteriorating, i.e. residual income less than zero.

Residual income is then equal to:
-3.59% x TA = -13.64
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