Stereo Warehouse is a U.S. retailer that offers employees a defined-benefit pension plan and stock options as part of its compensation package. Peter Friedland, CFA, is an equity analyst concerned with earnings quality. He is particularly interested in whether the discretionary assumptions the company is making regarding compensation plans are contributing
EXHIBIT 14-19 Assumptions Used for Stereo Warehouse Defined-Benefit Plan
|
2008 |
2007 |
2006 |
|
|
Expected long-term rate of return on plan assets |
6.06% |
6.14% |
6.79% |
|
Discount rate |
4.85 |
4.94 |
5.38 |
|
Salary increase |
4.00 |
4.44 |
4.25 |
|
inflation |
3.00 |
2.72 |
2.45 |
EXHIBIT 14-20 Allocation of Stereo Warehouse Defined-Benefit Plan Assets
|
2008 |
2009 |
|
|
Equity securities |
90% |
80% |
|
Debt securities |
10 |
20 |
EXHIBIT 14-21 Option Valuation Assumptions
|
2008 |
2007 |
2006 |
|
|
Risk free rate |
4.6% |
3.8% |
2.4% |
|
Expected life |
5.0yrs |
5.0yrs |
5.0yrs |
|
Dividend yield |
1.0% |
0.0% |
0.0% |
|
Expected volatility |
29% |
31% |
35% |
to the recent earnings growth at Stereo Warehouse. He gathers information from the company’s regulatory filings regarding the pension plan assumptions in Exhibit 14-19, the actual asset allocation for the pension plan in Exhibit 14-20, and the assumptions related to option valuation in Exhibit 14-21.
The pension assumptions being used by Stereo Warehouse may be internally inconsistent with respect to
a. asset returns only.
b. inflation expectations only.
c. both inflation expectations and asset returns.