Exam 13: Valuation: Earnings-Based Approaches

Accounting earnings numbers provide a basis for valuation because earnings are the primary measure of ______________________________ produced by the accrual accounting system.

Jones Corp. Use this information to answer the following questions: At the end of 2005 Jones Corp. developed the following forecasts of net income: Management believes that after 2010 Jones will grow at a rate of 7% each year. Total common shareholders' was $112,768 on December 31, 2005. Jones has not established a dividend and does not plan on paying dividends during 2006 to 2010, its cost of equity capital is 12%. What would be Jones' residual income in 2008?

Investors have invested $25,000 in common equity in a company. Given the risk inherent in the company the investors expect to earn a 15 percent return. In addition, the investors expect the company to return all income to investors in the form of dividends. The company earns $4,000 the first year. For this company determine the following:

Residual income is

What is meant by the term clean surplus accounting?

Why is the weighted average cost of capital not used as the discount rate when computing residual income?

Builder, Inc. is a distributor of tools and building supplies. Management for the company has developed the following forecasts of net income: Management expects net income to grow at a rate of 7 percent per year after 2010 and the company's cost of equity capital is 14%. Management has set a dividend payout ratio equal to 25% of net income and plans to continue this policy. Builder's common shareholders' equity at January 1, 2006 is $544,902. Required:

Residual income valuation focuses on

If an analyst expects a firm to generate net income each period exactly equal to required earnings, then the value of the firm will be equal to the ______________________________ of common shareholders' equity.

Assume that a firm had shareholders' equity on the balance sheet at a book value of $1,200 at the end of 2005. During 2006 the firm earns net income of $900, pays dividends to shareholders of $400, and issues new stock to raise $250 of capital. The book value of shareholders equity at the end of 2006 is:

Accounting for the book value of common shareholders' equity in a firm can be expressed as follows: BV_t = BV_t-1 + ____________________ - D_t.

When debating the issue of whether to use free cash flows or earnings in a valuation model economists sometimes argue that ____________________ can be subject to purposeful management by a firm and thus make them less useful.

Required earnings are the

Power, Inc. is a distributor of electrical supplies and tools. Management for the company has developed the following forecasts of net income: Red Ranger, CFO of Power, Inc. expects net income to grow at a rate of 9 percent per year after 2011 and the company's cost of equity capital is 15%. Management plans to payout all income in dividends and plans to continue this policy into the future. Power's common shareholders' equity at January 1, 2006 is $100,000. Required:

The residual income valuation approach assumes that accounting for net income and book value of shareholders' equity follows ________________________________________.

Currently U.S. GAAP does not follow clean surplus accounting, what are the four dirty surplus items that do not flow through net income?

Investors have invested $25,000 in common equity in a company. Given the risk inherent in the company the investors expect to earn a 15 percent return. In addition, the investors expect that the company will reinvest all income in projects that will earn 16%. The company is forecasted to earn $6,000 the first year, $5,000 the second year, $5,500 the third year and $6,244 each year after the third year. For this company determine the company's residual income valuation (round all numbers to the nearest dollar).

If investors have invested $25,000 of common equity in a company and it is determined that the required earnings of the company are $2,250 each period, then investors must expect to earn what return?

Clean surplus accounting means that ____________________ include all direct capital transactions between the firm and the common equity shareholders.

Assume that a firm's book value at the beginning of the year is $12,500 and that the firm reports net income of $3,200 and pays dividends of $1,100_. What will the firm's book value at the end of the year?