Stereo Warehouse is a US retailer that off ers employees a defi ned benefi t pension plan andstock options as part of its compensation package. Stereo Warehouse prepares its fi nancialstatements in accordance with US GAAP.Peter Friedland, CFA, is an equity analyst concerned with earnings quality. He is particularly interested in whether the discretionary assumptions the company is making regardingcompensation plans are contributing to the recent earnings growth at Stereo Warehouse. Hegathers information from the company’s regulatory fi lings regarding the pension plan assumptions in Exhibit 4 and the assumptions related to option valuation in Exhibit 5.EXHIBIT 4 Assumptions Used for Stereo Warehouse Defi ned Benefi t Plan2009 2008 2007Expected long-term rate of return on plan assets 6.06% 6.14% 6.79%Discount rate 4.85 4.94 5.38Estimated future salary increases 4.00 4.44 4.25Infl ation 3.00 2.72 2.45EXHIBIT 5 Option Valuation Assumptions2009 2008 2007Risk-free rate 4.6% 3.8% 2.4%Expected life 5.0 yrs 4.5 yrs 5.0 yrsDividend yield 1.0% 0.0% 0.0%Expected volatility 29% 31% 35%14 . Compared to the 2009 reported fi nancial statements, if Stereo Warehouse had used thesame expected long-term rate of return on plan assets assumption in 2009 as it used in2007, its year-end 2009 pension obligation would most likely have been:A . lower.B . higher.C . the same.
Stereo Warehouse is a US retailer that off ers employees a defi ned benefi t pension plan and
stock options as part of its compensation package. Stereo Warehouse prepares its fi nancial
statements in accordance with US GAAP.
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 to the recent earnings growth at Stereo Warehouse. He
gathers information from the company’s regulatory fi lings regarding the pension plan assumptions in Exhibit 4 and the assumptions related to option valuation in Exhibit 5.
EXHIBIT 4 Assumptions Used for Stereo Warehouse Defi ned Benefi t Plan
2009 2008 2007
Expected long-term rate of
Discount rate 4.85 4.94 5.38
Estimated future salary increases 4.00 4.44 4.25
Infl ation 3.00 2.72 2.45
EXHIBIT 5 Option Valuation Assumptions
2009 2008 2007
Risk-free rate 4.6% 3.8% 2.4%
Expected life 5.0 yrs 4.5 yrs 5.0 yrs
Dividend yield 1.0% 0.0% 0.0%
Expected volatility 29% 31% 35%
14 . Compared to the 2009 reported fi nancial statements, if Stereo Warehouse had used the
same expected long-term rate of return on plan assets assumption in 2009 as it used in
2007, its year-end 2009 pension obligation would most likely have been:
A . lower.
B . higher.
C . the same.
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