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 © CFA Institute. For candidate use only. Not for distribution.

CORPORATE ISSUERS,
EQUITY VALUATION

CFA® Program Curriculum

2023 • LEVEL 2 • VOLUME 3
© CFA Institute. For candidate use only. Not for distribution.

©2022 by CFA Institute. All rights reserved. This copyright covers material written
expressly for this volume by the editor/s as well as the compilation itself. It does
not cover the individual selections herein that first appeared elsewhere. Permission
to reprint these has been obtained by CFA Institute for this edition only. Further
reproductions by any means, electronic or mechanical, including photocopying and
recording, or by any information storage or retrieval systems, must be arranged with
the individual copyright holders noted.
CFA®, Chartered Financial Analyst®, AIMR-PPS®, and GIPS® are just a few of the
trademarks owned by CFA Institute. To view a list of CFA Institute trademarks and the
Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org.
This publication is designed to provide accurate and authoritative information
in regard to the subject matter covered. It is sold with the understanding that the
publisher is not engaged in rendering legal, accounting, or other professional service.
If legal advice or other expert assistance is required, the services of a competent pro-
fessional should be sought.
All trademarks, service marks, registered trademarks, and registered service marks
are the property of their respective owners and are used herein for identification
purposes only.
ISBN 978-1-953337-07-8 (paper)
ISBN 978-1-953337-31-3 (ebook)
2022
 © CFA Institute. For candidate use only. Not for distribution.

CONTENTS

How to Use the CFA Program Curriculum   ix

Errata   ix
Designing Your Personal Study Program   ix
CFA Institute Learning Ecosystem (LES)   x
Feedback   x

Corporate Issuers

Learning Module 1 Financial Statement Modeling   3

Introduction   4
Financial Statement Modeling: An Overview   4
Income Statement Modeling: Operating Costs   10
Modeling Operating Costs: Cost of Goods Sold and SG&A   14
SG&A Expenses   16
Modeling Non-operating Costs and Other Items   22
Financing Expenses   22
Corporate Income Tax   24
Income Statement Modeling: Other Items   28
Balance Sheet and Cash Flow Statement Modeling   28
Building a Financial Statement Model   34
Company Overview   34
Revenue Forecast   36
COGS   37
SG&A Expenses and Other Operating Expense   37
Operating Profit by Segment   38
Non-Operating Items   40
Corporate Income Tax Forecast   41
Shares Outstanding   41
Pro Forma Income Statement    42
Pro Forma Statement of Cash Flows    43
Capital Investments and Depreciation Forecasts   44
Working Capital Forecasts   45
Forecasted Cash Flow Statement   45
Forecasted Balance Sheet   46
Valuation Model Inputs   48
Behavioral Finance and Analyst Forecasts   48
Overconfidence in Forecasting   48
Illusion of Control   50
Conservatism Bias   51
Representativeness Bias   52
Confirmation Bias   54
The Impact of Competitive Factors in Prices and Costs   55
Cognac Industry Overview   55
Inflation and Deflation   64
Sales Projections with Inflation and Deflation   64

The Financial Statement Modeling learning module should appear in the Financial Statement Analysis topic area, not in the Corporate Issuers topic area.
We regret the error in its placement in the print curriculum. It has been placed correctly in the candidate learning ecosystem online.
 © CFA Institute. For candidate use only. Not for distribution.
iv Contents

Cost Projections with Inflation and Deflation   69

Technological Developments   72
Long-Term Forecasting   83
Case Study: Estimating Normalized Revenue   84
Conclusions and Summary   88
Practice Problems   89
Solutions   119

Learning Module 2 Analysis of Dividends and Share Repurchases   137

Dividends: Forms and Effects on Shareholder Wealth and Financial Ratios   138
Dividends: Forms and Effects on Shareholder Wealth and Issuing
Company’s Financial Ratios   139
Dividend Policy and Company Value: Theories   145
Dividend Policy Does Not Matter   145
Dividend Policy Matters: The Bird in the Hand Argument   146
Dividend Policy Matters: The Tax Argument   146
Other Theoretical Issues: Signaling   147
The Information Content of Dividend Actions: Signaling   147
Agency Costs and Dividends as a Mechanism to Control Them   151
Other Theoretical Issues: Summary   153
Factors Affecting Dividend Policy in Practice   154
Investment Opportunities   154
The Expected Volatility of Future Earnings   155
Financial Flexibility   155
Tax Considerations   156
Flotation Costs   158
Contractual and Legal Restrictions   159
Factors Affecting Dividend Policy: Summary   159
Payout Policies   160
Stable Dividend Policy   161
Constant Dividend Payout Ratio Policy   163
Global Trends in Payout Policy   164
Share Repurchases   165
Share Repurchase Methods   166
Financial Statement Effects of Repurchases   168
Valuation Equivalence of Cash Dividends and Share Repurchase   171
The Dividend versus Share Repurchase Decision   173
Analysis of Dividend Safety   182
Summary   186
References   189
Practice Problems   190
Solutions   197

Learning Module 3 Environmental, Social, and Governance (ESG) Considerations in

Investment Analysis   201
Introduction   201
Ownership Structures and Their Effects on Corporate Governance   202
Dispersed vs. Concentrated Ownership   202
Conflicts within Different Ownership Structures   204

indicates an optional segment

 © CFA Institute. For candidate use only. Not for distribution.
Contents v

Types of Influential Shareholders   205

Effects of Ownership Structure on Corporate Governance   206
Evaluating Corporate Governance Policies and Procedures   208
Board Policies and Practices   209
Executive Remuneration   211
Shareholder Voting Rights   211
Identifying ESG-Related Risks and Opportunities   211
Materiality and Investment Horizon   212
Relevant ESG-Related Factors   212
Evaluating ESG-Related Risks and Opportunities   218
ESG Integration   218
Examples of ESG Integration   219
Summary   226
Practice Problems   228
Solutions   231

Learning Module 4 Cost of Capital: Advanced Topics   235

Introduction   235
Cost of Capital Factors   236
Top-Down External Factors   237
Bottom-Up Company Specific Factors   239
Cost of Capital Factors Summary   245
Estimating the Cost of Debt   247
Traded Debt   248
Non-Traded Debt   248
Bank Debt   249
Leases   250
International Considerations   251
The ERP   253
Historical Approach   254
Forward-Looking Approach   258
The Cost of Equity (Required Return on Equity)   263
DDMs   264
Bond Yield Plus Risk Premium Approach   265
Risk-Based Models   266
Estimating the Cost of Equity for Private Companies   269
International Considerations   271
Required Return on Equity Summary   274
Mini-Case 1   277
Gretna Engines   277
Mini-Case 2   283
Precision Irrigation   283
Practice Problems   286
Solutions   288

Learning Module 5 Corporate Restructuring   289

Introduction   289
Corporate Evolution, Actions, and Motivations   290
Corporate Life Cycle and Actions   290

indicates an optional segment

 © CFA Institute. For candidate use only. Not for distribution.
vi Contents

Motivations for Corporate Structural Change   291

Types of Corporate Restructurings   292
Evaluating Corporate Restructurings   307
Initial Evaluation   307
Preliminary Valuation   309
Modeling and Valuation   315
Pro Forma Weighted Average Cost of Capital   317
Evaluating Investment Actions   322
Equity Investment   323
Joint Venture   327
Acquisition   330
Evaluating Divestment Actions   334
Evaluating Restructuring Actions   341
Summary   348
Practice Problems   350
Solutions   354

Equity Valuation

Learning Module 1 Equity Valuation: Applications and Processes   359

Introduction   360
Value Definitions and Valuation Applications   360
Applications of Equity Valuation   363
Understanding the Business   366
Understanding the Business   366
Analysis of Financial Reports and Sources of Information   369
Sources of Information   371
Considerations in Using Accounting Information   373
Selecting the Appropriate Valuation Method   378
Selecting the Appropriate Valuation Model   379
Issues in Model Selection and Interpretation   382
Issues in Model Selection and Interpretation   384
The Analyst's Role and Responsibilities   385
Applying the Valuation Conclusion: The Analyst’s Role and
Responsibilities   386
Communicating Valuation Results   388
Contents of a Research Report   388
Format of a Research Report   391
Research Reporting Responsibilities   392
Summary   393
References   396
Practice Problems   397
Solutions   403

Learning Module 2 Discounted Dividend Valuation   405

Introduction   406
Present Value Models   407
The Dividend Discount Model   414
The Expression for a Single Holding Period   415

indicates an optional segment

 © CFA Institute. For candidate use only. Not for distribution.
Contents vii

The Expression for Multiple Holding Periods   416

The Gordon Growth Model   418
The Gordon Growth Model Equation   418
The Links among Dividend Growth, Earnings Growth, and Value
Appreciation in the Gordon Growth Model   425
Share Repurchases and The Implied Dividend Growth Rate   426
The Implied Dividend Growth Rate   427
The Gordon Growth Model: Other Issues   428
Gordon Growth Model and the Price-to-Earnings Ratio   430
Estimating a Required Return Using the Gordon Growth Model   432
The Gordon Growth Model: Concluding Remarks   433
Multistage Dividend Discount Models   433
Two-Stage Dividend Discount Model   435
Valuing a Non-Dividend-Paying Company   438
The H-Model and Three-Stage Dividend Discount Models   439
Three-Stage Dividend Discount Models   441
General Modeling and Estimating a Required Return Using Any DDM   446
Estimating a Required Return Using Any DDM   448
Multistage DDM: Concluding Remarks   449
The Financial Determinants of Growth Rates   450
Sustainable Growth Rate   450
Dividend Growth Rate, Retention Rate, and ROE Analysis   452
Financial Models and Dividends   455
Summary   456
References   460
Practice Problems   461
Solutions   473

Glossary G-1

indicates an optional segment

© CFA Institute. For candidate use only. Not for distribution.
 © CFA Institute. For candidate use only. Not for distribution.
ix

How to Use the CFA

Program Curriculum
The CFA® Program exams measure your mastery of the core knowledge, skills, and
abilities required to succeed as an investment professional. These core competencies
are the basis for the Candidate Body of Knowledge (CBOK™). The CBOK consists of
four components:
■ A broad outline that lists the major CFA Program topic areas (www.
cfainstitute.org/programs/cfa/curriculum/cbok)
■ Topic area weights that indicate the relative exam weightings of the top-level
topic areas (www.cfainstitute.org/programs/cfa/curriculum)
■ Learning outcome statements (LOS) that advise candidates about the spe-
cific knowledge, skills, and abilities they should acquire from curriculum
content covering a topic area: LOS are provided in candidate study ses-
sions and at the beginning of each block of related content and the specific
lesson that covers them. We encourage you to review the information about
the LOS on our website (www.cfainstitute.org/programs/cfa/curriculum/
study-sessions), including the descriptions of LOS “command words” on the
candidate resources page at www.cfainstitute.org.
■ The CFA Program curriculum that candidates receive upon exam
registration
Therefore, the key to your success on the CFA exams is studying and understanding
the CBOK. You can learn more about the CBOK on our website: www.cfainstitute.
org/programs/cfa/curriculum/cbok.
The entire curriculum, including the practice questions, is the basis for all exam
questions and is selected or developed specifically to teach the knowledge, skills, and
abilities reflected in the CBOK.

ERRATA
The curriculum development process is rigorous and includes multiple rounds of
reviews by content experts. Despite our efforts to produce a curriculum that is free
of errors, there are instances where we must make corrections. Curriculum errata are
periodically updated and posted by exam level and test date online on the Curriculum
Errata webpage (www.cfainstitute.org/en/programs/submit-errata). If you believe you
have found an error in the curriculum, you can submit your concerns through our
curriculum errata reporting process found at the bottom of the Curriculum Errata
webpage.

DESIGNING YOUR PERSONAL STUDY PROGRAM

An orderly, systematic approach to exam preparation is critical. You should dedicate
a consistent block of time every week to reading and studying. Review the LOS both
before and after you study curriculum content to ensure that you have mastered the
 © CFA Institute. For candidate use only. Not for distribution.
x How to Use the CFA Program Curriculum

applicable content and can demonstrate the knowledge, skills, and abilities described
by the LOS and the assigned reading. Use the LOS self-check to track your progress
and highlight areas of weakness for later review.
Successful candidates report an average of more than 300 hours preparing for each
exam. Your preparation time will vary based on your prior education and experience,
and you will likely spend more time on some study sessions than on others.

CFA INSTITUTE LEARNING ECOSYSTEM (LES)

Your exam registration fee includes access to the CFA Program Learning Ecosystem
(LES). This digital learning platform provides access, even offline, to all of the curricu-
lum content and practice questions and is organized as a series of short online lessons
with associated practice questions. This tool is your one-stop location for all study
materials, including practice questions and mock exams, and the primary method by
which CFA Institute delivers your curriculum experience. The LES offers candidates
additional practice questions to test their knowledge, and some questions in the LES
provide a unique interactive experience.

FEEDBACK
Please send any comments or feedback to [email protected], and we will review
your suggestions carefully.
© CFA Institute. For candidate use only. Not for distribution.

Corporate Issuers
© CFA Institute. For candidate use only. Not for distribution.
 © CFA Institute. For candidate use only. Not for distribution.

LEARNING MODULE

1
Financial Statement Modeling
by Matthew L. Coffina, CFA, Anthony M. Fiore, CFA, and Antonius J. van
Ooijen, MSc, CFA.
Matthew L. Coffina, CFA, is at Morningstar Investment Management LLC (USA). Anthony
M. Fiore, CFA, is at Silvercrest Asset Management (USA). Antonius J. van Ooijen, MSc,
CFA, is at APG Asset Management (Netherlands).

LEARNING OUTCOMES
Mastery The candidate should be able to:

compare top-down, bottom-up, and hybrid approaches for

developing inputs to equity valuation models
compare “growth relative to GDP growth” and “market growth and
market share” approaches to forecasting revenue
evaluate whether economies of scale are present in an industry by
analyzing operating margins and sales levels
demonstrate methods to forecast cost of goods sold and operating
expenses
demonstrate methods to forecast non-operating items, financing
costs, and income taxes
describe approaches to balance sheet modeling
demonstrate the development of a sales-based pro forma company
model
explain how behavioral factors affect analyst forecasts and
recommend remedial actions for analyst biases
explain how competitive factors affect prices and costs
evaluate the competitive position of a company based on a Porter’s
five forces analysis
explain how to forecast industry and company sales and costs when
they are subject to price inflation or deflation
evaluate the effects of technological developments on demand, The Financial Statement
selling prices, costs, and margins Modeling learning module
should appear in the Financial
explain considerations in the choice of an explicit forecast horizon Statement Analysis topic area,
explain an analyst’s choices in developing projections beyond the not in the Corporate Issuers
topic area. We regret the error
short-term forecast horizon
in its placement in the print
curriculum. It has been placed
correctly in the candidate
learning ecosystem online.
 © CFA Institute. For candidate use only. Not for distribution.
4 Learning Module 1 Financial Statement Modeling

1 INTRODUCTION

compare top-down, bottom-up, and hybrid approaches for

developing inputs to equity valuation models
compare “growth relative to GDP growth” and “market growth and
market share” approaches to forecasting revenue

Financial statement modeling is a key step in the process of valuing companies and
the securities they have issued. We focus on how analysts use industry information
and corporate disclosures to forecast a company’s future financial results.
An effective financial statement model must be based on a thorough understanding
of a company’s business, management, strategy, external environment, and historical
results. Thus, an analyst begins with a review of the company and its environment—its
industry, key products, strategic position, management, competitors, suppliers, and
customers. Using this information, an analyst identifies key revenue and cost drivers
and assesses the likely impact of relevant trends, such as economic conditions and
technological developments. An analyst’s understanding of the fundamental drivers
of the business and assessment of future events provide the basis for forecast model
inputs. In other words, financial statement modeling is not merely a quantitative or
accounting exercise, it is the quantitative expression of an analyst’s expectations for
a company and its competitive environment.
We begin our discussion with an overview of developing a revenue forecast. We
then describe the general approach to forecasting each of the financial statements
and demonstrate the construction of a financial statement model, including fore-
casted revenue, income statements, balance sheets, and statements of cash flows.
Then, we describe five key behavioral biases that influence the modeling process and
strategies to mitigate them. We then turn to several important topics on the effects
of micro- and macroeconomic conditions on financial statement models: the impact
of competitive factors on prices and costs, the effects of inflation and deflation,
technological developments, and long-term forecasting considerations. The reading
concludes with a summary.
Most of the examples and exhibits used throughout the reading can be downloaded
as a Microsoft Excel workbook. Each worksheet in the workbook is labeled with the
corresponding example or exhibit number in the text.

Financial Statement Modeling: An Overview

Financial statement modeling generally begins with the income statement. The income
statement is a logical starting point because most companies derive most of their
value from future cash flow generation, determined primarily by the amount of future
operating income generated by the business. Exceptions include banks and insurance
companies, for which the value of existing assets and liabilities on the balance sheet
might be more relevant to the companies’ overall value than projected future income.
The income statement also provides a useful starting point for modeling a company’s
balance sheet and cash flow statement.
 © CFA Institute. For candidate use only. Not for distribution.
Introduction 5

Income Statement Modeling: Revenue

Companies receive revenue from multiple sources and can be analyzed by geographical
source, business segment, or product line. In a geographic analysis, the analyst places
a company’s revenue into various geographic groupings, which might or might not be
the same as the groupings provided by management in company disclosures. These
groupings can be narrowly defined, such as by individual countries, or more broadly
defined, such as by region of the world. A geographic analysis can be particularly
useful for companies operating in multiple countries with different underlying growth
rates or competitive dynamics. For example, a company’s sales might be experiencing
relatively slow growth in one region of the world and relatively fast growth in other
regions. By examining each region of the world separately, analysts can enhance their
understanding of overall growth.
Segment disclosures in companies’ financial reports are often a rich source of
information. Both International Financial Reporting Standards (IFRS) and US GAAP
require issuers to disclose financial information for any operating segment whose rev-
enue, operating income, or assets account for 10% or more of consolidated revenue,
operating income, or assets. Disclosures, typically in the notes to financial statements,
include how segments are defined; segment revenues, expenses, assets, and liabilities;
and a reconciliation of segment results to consolidated results. In addition to the
interim and annual financial reports issued by the company, important information
can often be found in other company disclosures, such as press releases, presentations,
and conference calls.
In a breakdown by segment, the analyst classifies a company’s revenue into various
business segments. Many companies operate in more than one industry or market
niche with widely differing economics. Although information is often available for the
different business segments, analysts should make an independent judgment about
whether management’s segmentation is relevant and material. Sometimes analysts
can regroup reported information in a manner that helps make important points.
Finally, a product line analysis provides the most granular level of detail. A prod-
uct line analysis is most relevant for a company with a manageably small number
of products that behave differently but when combined, account for most of the
company’s sales.
Example 1 introduces the first of many examples and exhibits that we use. Please
note that many numbers have been rounded; so, in replicating results based on the
numbers given in the text and exhibits, small apparent discrepancies could reflect
the rounding error.

EXAMPLE 1

Analysis of Revenue (1)

Novo Nordisk is a Denmark-based listed biopharmaceutical company. The
company provides detailed disclosure of revenue along geographic, business
segment, and product lines. All figures are in millions of Danish krone (DKK).
In its 2020 annual report, Novo Nordisk provided the following geographic break-
down of sales for the previous three years. The company also reported revenue
in two business segments: Diabetes and Obesity Care and Biopharmaceuticals.
Within each segment, disclosure on several individual product lines was also
provided. Exhibit 1 and Exhibit 2 are in the Example1 sheet in the downloadable
Microsoft Excel workbook.
Another Random Scribd Document
with Unrelated Content
The Project Gutenberg eBook of Master and
Maid
 This ebook is for the use of anyone anywhere in the United
States and most other parts of the world at no cost and with
almost no restrictions whatsoever. You may copy it, give it away
or re-use it under the terms of the Project Gutenberg License
included with this ebook or online at www.gutenberg.org. If you
are not located in the United States, you will have to check the
laws of the country where you are located before using this
eBook.

Title: Master and Maid

Creator: L. Allen Harker

Release date: April 7, 2017 [eBook #54504]

Most recently updated: July 28, 2018

Language: English

Credits: Produced by Al Haines

*** START OF THE PROJECT GUTENBERG EBOOK MASTER AND

MAID ***
 MASTER AND MAID

BY
MRS. L. ALLEN HARKER
AUTHOR OF "MISS ESPERANCE AND MR. WYCHERLY,"
"A ROMANCE OF THE NURSERY," "HIS FIRST LEAVE,"
"CONCERNING PAUL AND FIAMMETTA," ETC.

NEW YORK
CHARLES SCRIBNER'S SONS
1911

COPYRIGHT, 1910, BY
CHARLES SCRIBNER'S SONS
 TO
A. W. A. H.

"The dearest friend to me, the kindest man,

The best condition'd and unwearied spirit
In doing courtesies."

BOOKS BY L. ALLEN HARKER

PUBLISHED BY CHARLES SCRIBNER'S SONS
Master and Maid
Miss Esperance and Mr. Wycherly
Concerning Paul and Fiammetta
A Romance of the Nursery

MASTER AND MAID

CHAPTER I

On the second Friday of term Anthony Bevan, whom all his world
called "Bruiser Bevan," Housemaster of "B. House" in Hamchester
College, sat at dessert with three of his prefects. They had
exhaustively discussed the prospects of the coming football season,
had mutually exchanged their holiday experiences, and now, when it
was really time that the boys should betake themselves to their
several studies, they still lingered enjoying the last few pleasant
moments over the walnuts and the very light port that their
housemaster considered suited to their young digestions.
The big window at the end of the room stood open to the soft
September evening, and the sudden crunch of wheels upon the
newly gravelled drive was plainly audible, followed as it was by a
loud ring.
Master and boys fell silent, listening; and the parlour-maid
opened the dining-room door.
"Please, sir, there's a young lady--" she began; when the tale
was taken up by another voice, a young voice, singularly full and
pleasant:
"It's me, Tony, dear; and didn't you expect me? Dad promised
faithfully he would telegraph, but I suppose he forgot, as usual; and
oh, I'm so tired! We had a good crossing, but I couldn't sleep, it was
so stuffy."
Val, the Irish terrier, who always lay under his master's chair,
rushed at the newcomer, leaping upon her in rapturous and excited
welcome.
"Ah! 'tis the dear dog is pleased to see me. Down, Val, down!
You'll tear me to bits! Dear Val! but your welcome is too warm
altogether."
Into the circle of light thrown by the hanging lamp above the
table came a girl--a remarkably upright, small, slim girl of nineteen--
clad in a long light grey travelling coat, with a voluminous grey
gauze veil thrown back from her hat. Her little face was delicately
featured and pale. She was not particularly noticeable until she
spoke: then the timbre of her voice was arresting, it was so full and
sweet--not in the least degree loud, but singularly clear and musical,
with the unmistakable lilt of a Southern Irish brogue.
Tony Bevan leapt to his feet and advanced to meet her, holding
out both his hands.
"You, Lallie! now! Why, I didn't expect you for another fortnight.
Your father's letter only----"
"Well, I'm here, Tony," she interrupted, "sure enough, and I'm
ravenous. Can't I sit down with you and these gentlemen and have
some dinner now--at once? I'm fairly clean, for I had ever such a
wash at Birmingham."
The girl included the three prefects who stood around the table
in her remarks, smiling radiantly upon the assembled company, and
one of them hastily set his chair for her near the head of the table
which was Tony's place.
As she sat down she flashed another entrancing smile in the
direction of the prefect exclaiming:
"Bring another chair now and sit down by me, and don't on any
account let me spoil your dinners. Just take it that I'm a few courses
late, and you'll all be kind and keep me company. Have some more
nuts now, do, and then I'll feel more at home."
With the best will in the world those three prefects sat down
again, and each one hastily helped himself to nuts, in spite of the
fact that their host, far from seconding the newcomer's invitation,
turned right round in his chair to look at the clock.
The concentrated and admiring gaze of three pairs of eyes did
not in the smallest degree disconcert her. She was manifestly and
perfectly at her ease. Not so her host; he looked distinctly worried
and perturbed, though he hastened to ring the bell and order some
dinner for his evidently unexpected guest. Then he sat down and
poured her out a glass of claret.
"Child, have you come straight from Kerry?" he asked.
"I left home yesterday afternoon and crossed at night, and I
seem to have been travelling ever since."
"By yourself?" Tony asked anxiously.
"The Beamishes met me at Chester, and I had a bath and
luncheon at their house, and afterwards we drove round the city.
Oh! here's my dinner, and it's thankful I am to see it. How nice of
you not to have eaten all the duck!"
Again she included all the company in her charming smile, and
the senior prefect helped himself anew to nuts.
"You're very quiet, Tony," she said, turning to her host; "not a
patch upon Val in your welcome. Am I in the way? Is there not a bed
for me? If so, you must take me to some kind of a lodging after
dinner. Dad forbade me to go to any sort of an hotel."
"Of course, of course," Tony exclaimed hastily, "it will be quite
all right, only it is unfortunate that Miss Foster should happen to be
away this week, just when you have come."
"For my part," she said, catching her opposite neighbour's eye
and making a little face, "I think that I will manage to exist without
Miss Foster quite nicely till her return. Don't you worry about me,
Tony. I feel quite at home already. I know you, Mr. Berry," and she
nodded at the senior prefect. "Paddy's got your portrait, and you
come in lots of groups. Don't you think, Tony, you ought to present
these other gentlemen to me?"
 Mechanically Tony Bevan made the required introductions.
Whereupon the stranger added:
"I'm Paddy Clonmell's twin sister, you know; he was here last
term, but he's gone to Sandhurst now. You'll remember him quite
well, don't you?"
"Rather!" came in vigorous chorus from the three, and for the
moment Tony Bevan's anxious expression changed to one of
amusement.
The clock on the mantelpiece struck half-past eight.
"I think you fellows will need to go," said Tony; "Miss Clonmell
will excuse you; it's more than time you were doing your prep."
"Ah, well, we'll meet again to-morrow," Miss Clonmell
announced cheerfully. "There's ever so many of you I want to see. I
know lots of you by name as well as can be."
As the door was shut behind the last of the prefects the girl
drew her chair nearer to Tony's and laid a small deprecating hand
upon his arm.
"I'm afraid I'm fearfully in the way, Tony," she said, in a voice
that subtly combined excuse, apology, and reproach. "You don't
seem a bit glad to see me; and if you won't let me stay here, Dad
says I'd better go to the big girls' school in this town as a by-
something or other, and I'll hate it!"
"My dear," and as he spoke Tony patted the pleading little hand
that lay so lightly on his arm, "I am entirely delighted to see you, but
as I said before, it is unfortunate that Miss Foster should happen to
be away."
"Bother Miss Foster! I'm certain from all I've heard that she's
the very worst sort of Aunt Emileen. I'm glad she's away; I'd far
rather be here with you. Paddy says she's a regular catamaran.
Honestly, Tony, now, isn't she?"
Tony pursed up his lips, and tried hard to look severe as he
shook his head.
"I wish she were here just at present, anyhow. When
irresponsible children turn up unexpectedly, it needs some one strict
to look after them."
"Please, Tony, do you mind if I take off my hat? I didn't like to
do it before those boys, for I haven't a notion what state my hair is
in, but you've seen me at all times ever since I was a baby, haven't
you? And you'll excuse it."
She drew the big jade pins out of her hat and laid it on the
senior prefect's chair. Without it, she looked absurdly young: her
face was the face of a child, full of soft curves and sweet, blurred
outlines. There was something timid and beseeching in the dark
eyes she raised to Tony Bevan so confidingly: eyes black-lashed,
with faint blue shadows underneath--the "mark of the dirty finger"
that every pretty Irishwoman is proud to possess.
"You can look after me beautifully yourself, Tony, dear; that's
why I've come. Dad said I'd be safer with you than any one."
"But, my child, I am in College the greater part of the day. Every
minute of my time is filled up in school and out. As it is, I have an
appointment with the Chairman of the Playground Committee in five
minutes. What will you do with yourself?"
"Can't I see the chairman too? Well then, where's Paunch?
Couldn't he come and talk to me for a little bit--just while you settle
with this other man?"
 "Hush! You must not call Mr. Johns by that nickname here.
Besides, he's taking prep., and would be impossible in any case."
"Now, Tony, don't you be hushing me for saying 'Paunch.'
Everybody calls him Paunch. I've heard you do it yourself."
"Yes, Lallie, I dare say you have, but not here. It would be most
disrespectful and rude----"
"Good gracious, Tony! You don't imagine I'm going to call the
man Paunch to his face, do you? Did you think that when he was
introduced to me I'd make him a curtsey like this"--here she arose
and swept a magnificent curtsey--"and say, 'I'm delighted to make
your acquaintance Mr. Paunch; I've heard a vast deal about you one
way and another'? Don't be a goose, Tony! What about Matron? She
hasn't left, has she? Paddy says she's a regular brick, and anyway it
won't be a bit duller for me here than it was with Aunt Emileen
whenever Dad was away."
"Child, who is Aunt Emileen? I don't seem to have heard of her
before. Couldn't she come and be with you for the next few days?"
The girl burst into sudden laughter--infectious, musical, Irish
laughter. She rocked to and fro in her mirth, and suddenly snuggling
up to Tony Bevan, rubbed her head against his shoulder.
"Oh, Tony, you are too delicious! She can certainly come if you
want her, but I'm not sure that you'd think her much good."
"Sit up, Lallie, there's some one coming down the drive. You
haven't answered my question. Who and where is Aunt Emileen?"
"Aunt Emileen is my chaperon, but she suffers from delicate
health. When Dad took a little house at Fairham last November--and
a nice soft winter it was--he told everybody about Aunt Emileen, so
that no one should come pestering him and suggesting some nice
widow lady to keep house and take care of me. And she answered
very well indeed, though it was a little difficult when the clergyman
wanted to call and see her." Again she lapsed into that absurd
infectious laughter.
"But whose aunt is she?" persisted the bewildered Tony. "I know
your father hasn't any sisters, and your dear mother was an only
girl. Is she the wife of one of your uncles? Or is she your father's
aunt?"
"Honestly, Tony, I can't tell you any more about the lady except
that she's Aunt Emileen."
"But what's her surname?"
"I can't tell you, Tony, for I don't know; we never bothered
about a surname."
"Now, that's ridiculous, Lallie; the servants couldn't call her Aunt
Emileen."
"Oh, Tony, you'll kill me, you're so funny. Listen, and I'll tell you
all about it. Aunt Emileen is--a creation, a figment of Dad's brain, a
sop thrown to conventionality by the most unconventional man in
creation: a Mrs. Harris. She could be as strict and stiff and
pernicketty as ever she liked, for she couldn't interfere with us really;
and she pleased people very much, but they were sorry she was
such an invalid."
"But do you mean to tell me that your father really talked about
her to strangers?"
"Of course he did. That's what she was for; we didn't want her.
So sympathetic he was; and then he'd break off and joke about her
Low Church leanings--she always reads the Rock, does Aunt
Emileen--and her wool-work, and her missionary box, and her very
strict views of life and its responsibilities--oh, there were some
people quite pitied me having such an old fuss to look after me."
Tony sighed.
"I really don't know which is the more incorrigible infant, you or
your father. However, you'd better get to bed now and we can see in
the morning what it will be best to do. I must see that chap at once;
Ford announced him in the middle of your interesting narrative
about Aunt Emileen. You must be dreadfully tired, poor child! I'll ask
Matron to look after you to-night; come with me."
"Can't I just go and say good-night to those nice boys and see
their little studies?"
"No, my dear, you most certainly can't. You must promise me,
Lallie, that you will never go into the boys' part of the house unless I
or Miss Foster be with you."
Lallie sighed deeply.
"I promise, Tony, but it is hard. I did like them so much, and it
would have cheered me up."
The musical voice was most submissive, but in addition it
suggested much fatigue and loneliness and disappointment; and
poor Tony Bevan felt a perfect brute. Her dark eyes followed him
reproachfully as he held the door open for her, and she paused on
the threshold to say beseechingly:
"Don't try to be an Uncle Emileen, Tony; the part doesn't suit
you one little bit, and I know you'll never be able to keep it up. I'll
be a jewel of a girl and a paragon of propriety without you looking
so solemn and trying to talk so preachey. You'll be quite used to me
being here in a day or two, and I'm sure I'll get on with the boys like
anything."
 "My dear, you misunderstand me; I am delighted to have you,
and I hope you will be very happy. It is only that I am so sorry that
Miss Foster----"
"Tony, if you talk any more about Miss Foster I'll pinch you. I tell
you I'm thankful she's away. Now take me upstairs to my bed."
Matron, trim and neat in the uniform of a hospital nurse, met
them at the bedroom door. Lallie held out both her hands in
greeting.
"I'm ever so pleased to meet you, Matron, dear," she cried in
her sweet voice. "You'll remember my brother, Paddy Clonmell? he's
devoted to you, and I'm to give you his love and no end of
messages."
The matron's kind, worn face beamed.
"Mr. Clonmell's sister, isn't it, sir?" she said, turning to Tony.
"She has arrived before you expected her, so I've put her in Miss
Foster's room for to-night. I will see that her own is all in order to-
morrow. I'll look after her and take care that she is comfortable."
"Good-night, Lallie," said Tony, looking much relieved. "Don't
trouble to get up to breakfast; Ford will bring you some upstairs.
Sleep well!"
He turned to depart, but the girl came flying after him to the
head of the stairs.
"Aren't you going to kiss me good-night, Tony?" she cried
reproachfully, "an' me so tired and homesick and all."
She turned up her face towards his--the pathetic, tired child-
face.
Tony Bevan's somewhat weather-beaten countenance turned a
dusky crimson. He dropped a hasty kiss on the very top of her head
and fled down the staircase without looking back.
Matron, standing in the doorway, watched the little scene with
considerable interest.
"Perhaps he'd rather I didn't kiss him now I'm here," Lallie said
meditatively. "What do you think, Matron?"
The girl evidently asked her opinion in all good faith, and the
matron, who had a kind heart for everything young and a sincere
liking for the head of the house, said diplomatically:
"Of course I know Mr. Bevan's just like a dear uncle to you and
your brother; but if I was you, I don't think I'd expect him to kiss
you while you're here. It is a bit different being in a College House,
you know, to what it is at home, now isn't it?"
"It is, indeed," Lallie agreed fervently. "Tony seems so funny, so
stiff and stand-off; not a bit like he is when he comes over to us.
We're all so fond of him, servants and everybody."
"Of course you are, and so you will be here," the matron said
briskly. "Mr. Bevan is an exceedingly nice gentleman and a great
favourite. But, you know, a gentleman who is a schoolmaster must
be a bit strict in term time or he could never keep any order at all."
"You think that's it?" said Lallie, much comforted. "Of course I
can understand that. Paddy said he was quite different with us over
in Kerry to what he is here. I don't mind a bit if that's all. I was
afraid perhaps he'd taken a dislike to me."
"I don't think anybody could do that," the matron remarked
consolingly. "You see, Mr. Bevan only got your papa's letter, saying
you were coming, this morning, and I know he didn't expect you for
some days. Somehow, your papa had not made it clear you were
coming at once; and Mr. Bevan was upset to think that nothing was
ready for you, and Miss Foster being away----"
"I'd rather have you than twenty Miss Fosters," cried Lallie,
throwing her arms around Matron's neck. "You're a dear kind
woman, and I love you."

CHAPTER II

Mr. Nicholl, Chairman of the Playground Committee--commonly

known as "young Nick" to distinguish him from his brother, "old
Nick," a master of irascible disposition--sat awaiting Tony Bevan's
collaboration in that gentleman's comfortable study. While he waited,
young Nick indulged in all manner of romantic surmises as to his
colleague's probable engagement during the recent vacation. Young
Nick was really young, and was not in the least short-sighted. The
brilliantly lighted dining-room and its two occupants were almost
forced upon his notice as he walked up the drive to B. House, and it
was with the greatest interest, tempered by considerable good-
natured amusement, that he beheld Tony Bevan, shyest and,
apparently, most confirmed of bachelors, in an attitude that implied
familiar, and even tender relations, with so young and attractive a
girl.
"Sly dog, old Tony," he reflected. "Kept it uncommonly dark till
he springs the girl upon us. She must be years younger than he is--
wonder what she saw in old Tony? I'd like to know how the affair
strikes Miss Foster--suppose she cleared out to give 'em a few
minutes together. Shouldn't have chosen that room to spoon in if I'd
been them--too public by far. Wonder how long he'll keep me waiting
here? Shouldn't have thought old Tony would have had the courage
to face Miss Foster. I'd have done it by letter if I'd been in his shoes;
perhaps he did. Anyway, she won't half like it. Thought she was a
fixture here for evermore, and pitied old Tony from the bottom of my
heart. Well! Well! If ever a man was safe from matrimony, old Tony
seemed that chap--but no one's safe. Only she really does look
rather too much of a kiddie for him. Good old Tony! he's a thorough
sportsman and deserves the best of luck, but it's quaint of him to
spring her upon us without saying a word first. I wonder why now---
-"
Here young Nick's reflections were interrupted by the entrance
of their subject, a little breathless; a little rumpled about the hair, for
Lallie at parting had thrown her arms about his neck with more
warmth than discretion; a little stirred out of his usual comfortable
serenity.
Young Nick held out his hand, smiling broadly.
"It's no use pretending I didn't see, old chap, for I did. Heartiest
grats.----"
Tony Bevan stepped back a pace, nor did he make any attempt
to clasp the proffered hand. "Look here, Nicholl. For heaven's sake
don't let there be any mistake of that sort; that child is Paddy
Clonmell's sister----"
Tony paused; and young Nick, thoroughly enjoying his evident
discomfort, remarked encouragingly.
"Well, there's no objection in that, is there?"
 "Confound it!" Tony Bevan exclaimed angrily. "You've got hold of
a totally wrong idea; that child has been sent to me by her father--
by her father, mind you--to look after while he goes big game
shooting in India this winter. I've known her since she was a month
old, and I've known him since I was his fag here, five-and-twenty
years ago. She's always looked on me as a sort of uncle, and she's
demonstrative, poor little girl, like all the Irish----"
"I beg your pardon, I'm sure," said young Nick, with blue eyes
that would twinkle merrily in spite of all his efforts to the contrary;
"but you must confess it was a natural misconception. You see,
you'd kept it so uncommonly dark about her coming."
"Kept it dark!" Tony echoed indignantly. "Kept it dark! Why, I
only knew myself that Clonmell wanted me to have her this morning;
and in his letter he said, 'in a week or so'; then the child appears to-
night, wholly unexpectedly, and it's deuced awkward, for Miss
Foster's gone away for the week-end to a niece's wedding."
"Can't you get one of the married masters to have her till Miss
Foster comes back?"
"No, I can't do that; she'd be awfully hurt. They're all the soul of
hospitality themselves, and I could never make her understand my
reasons. I must worry through somehow, only don't you go off with
any ridiculously wrong impression."
"Of course not, of course not," young Nick remarked solemnly,
still gazing at Tony with eyes that seemed unable quite to see him in
this new rôle of guardian to a young lady.
They stared at each other in silence for a minute, and what
young Nick saw was a broad-shouldered, tall man, rather short-
necked, very square-jawed, brown and weather-beaten as to
complexion; a well-shaved man with a trustworthy but by no means
beautiful mouth, except when he smiled, when two rows of strong,
absolutely perfect teeth, redeemed its plainness. Of Tony Bevan's
nose, the less said the better. It was inconspicuous and far from
classical in shape, but his eyes were really fine: humorous, clear,
very brown eyes that were in truth the mirrors of a kind and candid
soul. His head was good, with plenty of breadth and height above
the ear; his hair thick and usually very smooth and sleek.
"Clonmell senior must surely have married very young if you
were his fag here," young Nick continued.
"Clonmell married in his second year at Balliol, and Lallie and
Paddy were born while he was still an undergraduate. He's just
twenty-three years older than the twins--in years; in mind and
conduct I do believe he's younger than either of them, and heaven
knows they're young enough. Of course the Balliol authorities were
furious at his marriage, but he was so brilliant, they let him stay on,
for they didn't want to lose him. He was up five years you know, and
took all sorts of honours in classics. It was just the same here; any
other chap would have got the sack for half the things he did, but
they knew he was safe for a Balliol scholarship and didn't want to
lose him."
"I've seen his name up in the big classical. Was he like Paddy?"
"Very like Paddy. Didn't you see him when he was down here for
the last concert, standing on a chair and singing 'Auld Lang Syne,'
long after he ought to have shut up? Paddy's the living image of
what he was at the same age, but hasn't half his brains. When he
was here he had his prefect's star taken away three times; got it
back; and finally they had to make him head of his house, for he
was already captain of the eleven; and for years won every short
race in the sports. But you could never tell what he'd do next. It
wasn't that he broke rules, so much as that he always seemed to
think of doing things no mortal had conceived possible. No code of
rules on earth could be framed to forbid the doings of Fitzroy
Clonmell."
"Yet I suppose he was a good chap, really? Paddy was a
thoroughly nice boy, with all his vagaries."
"So was his father. Everybody liked him; everybody likes him to
this day. He looks far too young to be anybody's father, and is
tremendously popular wherever he is; but he's never in one place
long--he's the most restless fellow in the world--and now he has
gone to India, and left Lallie on my hands."
"Surely it was an odd thing to do? A house for boys in a public
school seems an incongruous sort of place to select."
"It's just because it is a house for boys he has selected it. His
theory is that nowhere is a girl so safe as surrounded by boys and
men. I can see his reasoning myself, but you can't make the world
see it. However, we'd better get those times fixed up and fit in the
various teams. All that beastly physical drill to arrange, too--but you
understand, don't you, Nicholl?"
"I quite understand," young Nick replied with so profound a
gravity that Tony instantly suspected him of a desire to laugh.
They lit their pipes, and for an hour or more wrestled with the
problem in hand. Then young Nick departed.
The instant Tony was left alone he sat him down in a
comfortable chair, switched on the electric light behind his head, and
drew from his pocket a letter. First of all he looked at the date, which
he had not done when he read it in the morning. It was dated eight
days back, but the postmark was that of the day before.

"Dear old Tony," it ran, "one always thinks of you when one wants
anything done in a hurry, and done most uncommonly well. That's
what you get by being so confoundedly conscientious and good-
natured. The combination is a rare one. I, for instance, am good-
natured, but my worst enemy couldn't call me tiresomely
conscientious. Whenever you see my handwriting, you will say,
'Wonder what young Fitz wants now? Of course he wants
something,' and of course I do. I want you to look after Lallie for me
till the end of March. You've got a magnificent big house--far too
large for a bachelor like you. You've got a lady-housekeeper whose
manifest propriety is so stupendous that even Paddy is awed by it--a
lady, I am sure, estimable in every respect--and you have fifty boys
ranging from thirteen to nineteen. Oh, yes! and I forgot the worthy
Paunch and Val. Now if you can't, amongst you, look after my little
girl for six months you ought to be ashamed of yourselves. She's too
old to put to school; I don't want to leave her with hunting friends
where she'd be engaged and perhaps married before I got back.
Young men are for ever falling in love with Lallie of late, and it's a
terrible nuisance. She cares not a penny for any of them, so long as
I am there to prove by comparison how inferior they all are to her
own father. But with me away, who knows but that their
blandishments might prevail? And I have other plans for Lallie--but
not yet. As you know, I've brought her up in a sensible reasonable
human sort of fashion. She has been taught to look upon mankind--
and by mankind I mean the male portion of humanity--as fellow
creatures, just as much deserving of kindness and trust and
straightforward dealing as girls or women; and because she looks
upon them as fellow-creatures, with no ridiculous mystery or
conventional barriers between her and them, she is far safer than
most girls not to make a fool of herself or to be taken in by cheap
external attractions. Of course she's a bit of a flirt--what self-
respecting Irish girl is not?--and your big boys will all be sighing at
her shrine, but it will neither do them nor her any harm.
"I don't often speak of Alice these days, but I never forget, and
I know you'll be kind to my little girl for her sake. Let the child go to
the dancing school, though there's little they can teach her; and she
can keep up her singing, and perhaps she'd better ride, though
riding with a master will be little to Lallie's taste. I enclose a cheque
for the lessons, etc. She's a good girl, Tony; and in spite of her
unusually sensible up-bringing, is as delicately feminine in all her
instincts as any old Tabby in Hamchester.
"Lord Nenogh offered me third gun in his shoot in India this cold
weather, and I couldn't resist it. I was getting a bit musty. I've been
bear-leading those children for eighteen months--ever since dear old
Madame died. Lallie and I always hit it off perfectly, but Paddy's too
like me, and gets on my nerves and reminds me that I'm not so
young as I was, and I felt I needed a complete change of scene and
people, if I am to remain the agreeable fellow I always have been;
and I couldn't take Lallie with me tiger shooting, now could I? We
sail from Marseilles in the Mooltan on the 29th; send me a line to the
poste restante there, just to tell me that my property has duly
reached you--as it should about the 23rd. Till then I shall be flying
about all over the place.
 "Take care of my Lallie.

"Yours as ever,
"Fitz."

The writing was small, close, upright, and distinct. When he had
read the letter through Tony examined the envelope and found from
its appearance that it had evidently spent a considerable time in
somebody's pocket: either that of the writer or of some
untrustworthy messenger.
He lit another pipe, and as he watched the fragrant clouds of
smoke roll forth and spend themselves about the room, his mind
was busy with memories of Fitzroy Clonmell; brilliant, inconsequent,
lovable failure.
"He wouldn't have been a failure if his wife had lived," Tony
always maintained to those who, remembering Fitz and his early
promise of notable achievements, lamented his falling off; his
wholesale violation of those youthful pledges.
Tony found himself going back to those first years at Oxford,
when brilliant Fitz did all he could to push his young schoolfellow
among the athletic set, where, reading man as Fitz undoubtedly had
been then, his place was quite as assured as in the schools. Tony
remembered his shock of surprise when in his first term he went to
Clonmell's rooms in the High, to find them tenanted by a brown-
haired, gentle-voiced girl who informed him she was "Mrs. Clonmell"-
-Alice Clonmell.