Formula Sheet (CFA Level2) Residual Income: Chapter 36: Method : RI ! "I # $%uit& Char'e !( RI !

$)S # (r * ) ** $%uit& Char'e ! Cost o+ $%uit& * ,otal Capital

Method 2: RI ! $-I, ( #t)# Capital Char'e ** Capital Char'e ! .ACC * ,otal Assets

/ or /

$0A ! "1)A, # (.ACC 2 ,otal Capital) **positive $0A !( m'mt addin' value "1)A, ! $-I, ( #t) M0A (Mar3et 0alue Added) ! Mar3et value o+ +irm # invested capital **evaluates the e2cess return over invested capital to see i+ 4e have a return5

Revie4in' $arnin's: 5 Chec3 accrual ratios +or -S and CF 25 Revie4 Revenue a5 Lar'e increase in 6S1 ("et A7R7Sales)2368 is a red +la'# sho4s ho4 %uic3l& the compan& is convertin' credit sales into cash 95 6etectin' acceleration o+ revenues: Cash Collected Ratio ! (Revenues7Cash Collected) #this ratio should not chan'e much i5 Cash Collected ! (Revenue # "et increase in A7R / net increase in de+erred revenue) c5 Chec3 +or lar'e increases in unearned revenue or lar'e decreases in unearned revenue#si'nal o+ lo4 %ualit& revenue5 d5 Revie4 accountin' methods# does the compan& use :-ill and ;old: # 4here compan& records revenue transaction &et customer has not &et ta3en o4nership o+ product7service e5 Is the compan& classi+&in' nonrecurrin' or non#operatin' revenue as operatin' revenue< 35 Revie4 $2penses a5 Focus on S=>A and C1=S i5 6epreciation > Amort can 9e in either S=>A or C1=S ii5 .atch out +or companies that have lar'e inventor& 9alances 97c there is lots o+ discretion as to the costs that are capitali?ed into inventor& 95 Calculate remainin' use+ul li+e o+ deprecia9le assets and compare to other companies +or a''ressive or conservative depreciation e2pense c5 Calculate 6I1 ("et inventor&7C1=S) 2 368# ho4 %uic3l& can the compan& convert inventor& in revenue d5 I+ compan& uses LIF1 method# e2amine the LIF1 reserve and an& LIF1 li%uidations that 4ould improve mar'ins5

e5 6e+errin' $2penses: Lar'e pro9lem is 4hen companies capitali?e costs that should have 9een e2pensed5 i5 6iscretion in capitali?in' costs +or ))>$ > intan'i9les ii5 -est 4a& to trac3 this is 'ro4th in net non#current assets: lar'e 'ro4th in net operatin' assets 4ill su''est lo4er +uture compan& per+ormance5 iii5 -asic rule o+ thum9: treat all asset 'ro4th as 9ad and impose a tou'h standard to re@ect the h&pothesis5