- CFA Exams
- CFA Level I Exam
- Study Session 11. Equity Valuation (3)
- Reading 30. Residual Income Valuation
- Subject 1. Calculating residual income

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**CFA Practice Question**

Based on the following information, calculate ABC Company's residual income using capital charge method:

- At the beginning of the fiscal period: debt - $150; equity - $250.
- Net income of the period: $50.
- Cost of equity: 15%.
- Cost of debt: 6%.
- Marginal tax rate: 35%.

Correct Answer: We have w

_{e}= $250/$400 = 0.625; w_{d}= 0.375.Since there is no preferred stock in the company's capital structure: WACC = 0.15 x 0.625 + 0.06 x 0.375 x (1 - 0.35) = 0.108375.

Capital Charge = Total Assets x WACC = $400 x 0.108375 = $43.35. It adjusts after-tax operating income by the total cost of capital.

RI = After-Tax Operating Income - Capital Charge = Net Income + Cost of Debt % x (1 - T) x Book Value of Debt - Capital Charge = $50 + 0.06 x (1 - 0.35) x $150 - $43.35 = $12.5.

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