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effect of OCI on Cost of Equity

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effect of OCI on Cost of Equity

  1. 1. EFFECT OF OTHER COMPREHENSIVE INCOME ON COST OF EQUITY CAPITAL (EVIDENCE FROM INDONESIA)1 Alex Johanes Simamora (alexjohanessimamora@gmail.com) ABSTRACT In Indonesia, convergence of IFRS has given change on presentation of financial statement, especially in income statement. According to Statement of Financial Accounting Standard no. 1 (Pernyataan Standar Akuntansi Keuangan no. 1) that has been converge to IFRS, other comprehensive income stated in income statement. Other comprehensive income is differences between fair value and historical value. Other comprehensive income is a result of the use of fair value, one of IFRS principles. The use of fair value will increase financial statement relevance. The more relevant information of financial statement, the less information risk will be taken by investor. Less information risk makes cost of equity will be decreased, because of expected return decreasing by investor. This research is aimed to examine effect of statement of other comprehensive income on cost of equity capital. Samples of this research are manufacture companies listed in Indonesian Stock Exchange (Bursa Efek Indonesia) from year 2011-2013. Cost of equity capital is measured by Ohlson Model. The results of this research shows that other comprehensive income affect cost of equity capital negatively. It indicates that other comprehensive income increase financial statement relevance, reduce information risk and decrease cost of equity capital. Keywords: Other Comprehensive Income, Cost of Equity Capital, Ohlson Model, IFRS (International Financial Reporting Standard) INTRODUCTION Accounting is essentially the picture of economic transactions translated into accounting data as financial statement (De Franco, Kothari and Verdi, 2011). Analysts believe that high quality financial statement could show current performance to evaluate past performance and to forecast future performance of the companies (De Franco, Kothari and Verdi, 2011). International Financial Reporting Standard (IFRS) is a set of standard issued by International Accounting Standard Board (IASB) to decrease lag between economic performance and accounting performance. IFRS will increase role of global capital market by providing comparable and high quality information to investors (Barth, 2008). One of IFRS principles is fair value. The use of fair value can show current condition of companies and make investors get information with low cost. 1 This paper was presented in β€œ3rd GADJAH MADA INTERNATIONAL CONFERENCE ON ECONOMICS AND BUSINESS” November 27th,2015; University Club,Gadjah Mada University,Yogykarta.
  2. 2. Indonesian Accountant Institute (Ikatan Akuntan Indonesia or IAI) is beginning convergence of IFRS since 2008. Convergence of IFRS is commitment of Ikatan Akuntan Indonesia as a member of International Federation of Accountants (IFAC). In 2009, Statement of Financial Accounting Standard no. 1 (Pernyataan Standar Akuntansi Keuangan or PSAK no. 1), about presentation of financial statements, has been converged to IFRS. According to the use of fair value, other comprehensive income is stated in income statement. Other comprehensive income contains of changes due to the use of fair value. Components of other comprehensive income are unrealized income (Pratiwi, Indriani and Midiastuty, 2012). Components of other comprehensive income consists of: β€œ(1) Changes in revaluation surplus of fixed assets and intangible assets, accordance to Pernyataan Standar Akuntansi Keuangan no. 16 about fixed assets and Pernyataan Standar Akuntansi Keuangan no. 19 about intangible assets. (2) Actuarial gains and losses on defined benefit plans, accordance to Pernyataan Standar Akutansi Keuangan no. 24 about employee benefits. (3) Gains and losses arising from translation of financial statements of foreign companies, accordance to Pernyataan Standar Akuntansi Keuangan no. 10 about effect of change in foreign exchange rate. (4) Gains and losses from re-measurement of financial assets categorized as "available for sale", accordance to Pernyataan Standar Akuntansi Keuangan no. 55 about recognition and measurement of financial instruments. (5) The effective portion of gains and losses of hedging instruments in order to hedge cash flows, accordance to Pernyataan Standar Akuntansi Keuangan no. 55 on recognition and measurement of financial instruments” (Indonesia, Ikatan Akuntan Indonesia, 2009, paragraph 5). Components of other comprehensive income show changes over the use of the fair value of assets and liabilities by the company. The use of fair value is more relevant in decision making than the historical value. Lin, Ramond and Casta (2007) stated that other comprehenive income have value relevance and affect stock price. Pratiwi, Indriani and Midiastuty (2012) also stated that other comprehensive income affect stock return. The use of fair value will show current condition of company. It will increase relevance of financial statement and decrease information risk (information asymetric) in decision making, especially by investors. It also make investors will get information about current value of companies with low cost. Decreasing of information risk and cost will decrease expected return by investor. Low expected return means company will pay low cost of equity capital. Value relevance can reduce cost of equity capital (Francis et al., 2004). In Indonesia, other comprehensive income is a new thing in financial reporting. Motivation of this research is to explore the explanatory power of other comprehensive income, especially in determining cost of equity capital. There are some previous research have examined about effect of IFRS on cost of equity capital. Merino, Plans and Guerrero (2014) stated that mandatory IFRS adoption in Spain have decrased cost of equity capital. Patro and Gupta (2014) stated that decreasing cost of equity capital happens in Hongkong and Phillipine after IFRS adoption. This research will examined if statement of other comprehensive income
  3. 3. statement as a form of fair value implementation (one of IFRS principles) will reduce cost of equity capital. RESEARCH PROBLEM Is statement of other comprehensive income affect cost of equity capital negatively? FAIR VALUE One of IFRS principles is fair value concept. Fair value concept allows companies to measure asset or liability that has been adjusted to the current circumstances. Fair value is market based measurement –estimated price of orderly transaction to sell assets or to shift liabilities between market participants at measurement date in current condition (Indonesia, Ikatan Akuntan Indonesia, 2013, paragraph 2). β€œFair values reflect the most current and complete expectation and estimation of the value of assets or liabilities, including the amounts, timing, and riskiness of the future cash flows attributable to assets or liabilities” (USA, CFA Institute, 2010, p.2). The advantage of using fair value is presentation of fair value, as the most relevant information, shows real economic activity measurement (USA, CFA Institute 2010). More relevant financial statement information, less cost of equity capital paid by companies (Francis et al., 2004). OTHER COMPREHENSIVE INCOME Indonesian Accountant Institute (Ikatan Akuntan Indonesia or IAI) is beginning convergence of IFRS since 2008. It means that fair value have been applied in Statement of Financial Accounting Standards (Pernyataan Standar Akuntansi Keuangan or PSAK). One of forms of the use of fair value is other comprehensive income statement. Components of other comprehensive income show changes over the use of the fair value of assets and liabilities by the company. In 2009, Statement of Financial Accounting Standard no. 1 (Pernyataan Standar Akuntansi Keuangan or PSAK no. 1), about presentation of financial statements, has been converged to IFRS. According to the use of fair value, other comprehensive income is stated in income statement. Other comprehensive income contains of changes due to the use of fair value. Components of other comprehensive income are unrealized income (Pratiwi, Indriani and Midiastuty, 2012). Components of other comprehensive income consists of: β€œ(1) Changes in revaluation surplus of fixed assets and intangible assets, accordance to Pernyataan Standar Akuntansi Keuangan no. 16 about fixed assets and Pernyataan Standar Akuntansi Keuangan no. 19 about intangible assets. (2) Actuarial gains and losses on defined benefit plans, accordance to Pernyataan Standar Akutansi Keuangan no. 24 about employee benefits. (3) Gains and losses arising from translation of financial statements of foreign companies, accordance to Pernyataan Standar Akuntansi Keuangan no. 10 about effect of change in foreign exchange rate. (4) Gains and losses from re-measurement of financial assets categorized as "available for sale", accordance to Pernyataan Standar Akuntansi Keuangan no. 55 about recognition and measurement of financial instruments. (5) The effective portion of gains and losses of hedging instruments in order to hedge cash flows,
  4. 4. accordance to Pernyataan Standar Akuntansi Keuangan no. 55 on recognition and measurement of financial instruments” (Indonesia, Ikatan Akuntan Indonesia, 2009, paragraph 5). Components of other comprehensive income are unrealized income (Pratiwi, Indriani and Midiastuty, 2012). COST OF EQUITY CAPITAL Cost of equity capital is cost charged by investors or shareholders, as equity owner, because company will use their equity as fund to do business activity. The cost is charged as rate of return expected by investors. There are some models to measure expected return as cost of equity capital, like Capital Assets Pricing Model (CAPM), Single Index Model (SIM), and Ohlson Model. CAPM measure expected return from stock market activity, showed by rate of free risk and market return as the components to calculate stock return. SIM measure expected return also from market activity with company factors consideration, showed by individu return and market return as the components to calculate stock return. Ohlson Model measure expected return with spesific financial statement factor; which is book value of equity, forcasted earnings per share in subsequent year and market price. This research will use Ohlson Model to measure cost of equity capital, because this research will examined one of financial statement information to predict cost of equity capital. HYPOTHESES DEVELOPMENT AND PREVIOUS RESEARCH Statament of other comprehensive income shows the differences between fair value and historical value, as an impact of the use of fair value in measuring assets and liabilities. β€œFair values reflect the most current and complete expectation and estimation of the value of assets or liabilities, including the amounts, timing, and riskiness of the future cash flows attributable to assets or liabilities” (USA, CFA Institute, 2010, p.2). The use of fair value, as the most relevant information, shows real economic activity measurement (USA, CFA Institute, 2010). Lin, Ramond and Casta (2007); Pratiwi, Indriani and Midiastuty (2012) stated that other comprehensive income have value relevance and affect stock price and return. Value relevance can reduce cost of equity capital (Francis et al. 2004). The more relevant financial statement, the less information risk (information asymetric) in decision making, especially by investors. It also make investors get current value of companies less cost. Decreasing of information risk and cost will decrease expected return by investor (low risk makes low return). Low expected return means company will pay low cost of equity capital. Companies that stated other comprehensive income will pay low cost of equity capital. There are some previous researchs explain relationship between other comprehensive income, value relevance, fair value and cost of equity capital. table 1 previous researchs Reasercher Research Title Result Lin, Ramond and Casta (2007) Value Relevance of Comprehensive Income and Its Components: Evidence from Major European Capital Markets Other comprehensive income affect stock price. Pratiwi, Indriani Relevansi Nilai Informasi Laporan Other comprehensive
  5. 5. and Midiastuty (2012) Keuangan Dan Komponen Laba Rugi Komprehensif Dalam Menjelaskan Harga Dan Return Saham income affect stock return. Francis et al. (2004) Costs of Equity and Earnings Attributes Value relevance reduce cost of equity capital Merino, Plans and Guerrero (2014) Mandatory IFRS Adoption and The Cost of Equity Capital: Evidence from Spanish Firms Mandatory IFRS adoption in Spain have decrased cost of equity capital Patro and Gupta (2014) Impact of International Financial Reporting Standards on Cost of Equity Capital for Asian Countries decrasing cost of equity capital happens in Hongkong and Phillipine after IFRS adoption Source: previous researchs Based on above explaination and previous research, hypotheses in this research is: Ha: Statement of other comprehensive income affect cost of equity capital negatively RESEARCH SAMPLE This research will use purposive sampling to determine sample with some criteria, which is: a. Manufacture companies listed in Indonesian Stock Exchange (IDX) from year 2011 to 2014. Choosing of manufacture industry because different industry gives different explanatory ability of accounting information which is resulted by different business activity. b. Companies issue financial statement in IDR c. Companies have positive equity value. Negative equity value means companies have insolvency problem. table 2 research sample Criteria Manufacture companies listed in IDX from year 2011 to 2014 Companies issue financial statement not in IDR Companies have negative equity value Data is not complete 136 (27) (6) (3) Number of companies 100 Number of observation (2011-2013) Outliers 300 (64) Total 236 RESEARCH VARIABLES AND MEASUREMENT Dependent variable in this research is cost of equity capital, measured with Ohlson model. π‘Ÿπ‘‘ = 𝐡𝑉𝐸𝑑 + 𝐸𝑃𝑆𝑑+1 βˆ’ 𝑃𝑑 𝑃𝑑 where, 𝐡𝑉𝐸𝑑 = π‘‡π‘œπ‘‘π‘Žπ‘™ πΈπ‘žπ‘’π‘–π‘‘π‘¦π‘‘ π‘‚π‘’π‘‘π‘ π‘‘π‘Žπ‘›π‘‘π‘–π‘›π‘” π‘†β„Žπ‘Žπ‘Ÿπ‘’π‘‘
  6. 6. 𝐸𝑃𝑆𝑑+1 = 𝑁𝑒𝑑 πΌπ‘›π‘π‘œπ‘šπ‘’ 𝑑+1 π‘‚π‘’π‘‘π‘ π‘‘π‘Žπ‘›π‘‘π‘–π‘›π‘” π‘†β„Žπ‘Žπ‘Ÿπ‘’π‘‘+1 π‘Ÿπ‘‘ 𝐡𝑉𝐸𝑑 𝐸𝑃𝑆𝑑+1 𝑃𝑑 = = = = Cost of equity capital period t Book value of equity period t Earnings per share period t Stock price on publication date of financial statement period t Independent variable in this research is statement of other comprehensive income, value 1 if company state it, 0 otherwise. Control variables in this research is other comprehensive income per share and delay of financial statement publication. Lin, Ramond and Casta (2007); Pratiwi, Indriani and Midiastuty (2012) stated that other comprehensive income have value relevance and affect stock price and return. It means that other comprehensive income have explanatory ability to affect stock investment decision making and also can predict cost of equity capital. Other comprehensive income per share calculated from: 𝑂𝑃𝑆𝑑 = 𝑂𝐢𝐼𝑑 π‘‚π‘’π‘‘π‘ π‘‘π‘Žπ‘›π‘‘π‘–π‘›π‘” π‘†β„Žπ‘Žπ‘Ÿπ‘’ 𝑑 𝑂𝑃𝑆𝑑 𝑂𝐢𝐼𝑑 = = Other comprehensive income per share period t Other comprehensive income period t Earlier financial statement publication will reduce cost of equity capital. Onwuchekwa (2013) stated that reporting delay will reduce quality of information and make investors get information costly. The earlier financial report issued to public, the earlier other comprehensive income information known by investors, and the lower cost of equity capital. Delay of financial repo will be calculated from days publication delay of financial statement, which is: π·π‘’π‘™π‘Žπ‘¦π‘‘ = π·π‘Žπ‘‘π‘’ π‘œπ‘“ πΉπ‘–π‘›π‘Žπ‘›π‘π‘–π‘Žπ‘™ π‘†π‘‘π‘Žπ‘‘π‘’π‘šπ‘’π‘›π‘‘ π‘ƒπ‘’π‘Ÿπ‘–π‘œπ‘‘π‘‘ βˆ’ π·π‘Žπ‘‘π‘’ π‘œπ‘“ πΉπ‘–π‘›π‘Žπ‘›π‘π‘–π‘Žπ‘™ π‘†π‘‘π‘Žπ‘‘π‘’π‘šπ‘’π‘›π‘‘ π‘ƒπ‘’π‘π‘™π‘–π‘π‘Žπ‘‘π‘–π‘œπ‘› π·π‘’π‘™π‘Žπ‘¦π‘‘ = Publication delay of financial statement of period t ANALYTICAL METHOD This research will use multiple regression to test the hypotheses. This research also will use classical assumptions test to make sure that regression model is valid. The regression model is: 𝐢𝑂𝐸𝐢 = 𝛼 + 𝛽1 𝑂𝐢𝐼 + 𝛽2 𝑂𝑃𝑆 + 𝛽3 π·πΈπΏπ΄π‘Œ where: COEC OCI OPS DELAY = = = = Cost of equity capital Statement of other comprehensive income Other comprehensive income per share Delay of financial statement Ha accepted if significance value below 0.05 and 𝛽1 have negative value.
  7. 7. RESULTS table 3 classical assumption test Tests Tools Result Notes Normality K-S test Sig. = 0.000 Distribution is not normal Normality (after trimming) K-S test Sig. = 0.056 Distribution is normal Heterocedasticity Glejser test Sig. above 0.05 Free of heterocedasticity problem Autocorellation DW test DW = 1.973 Free of autocorellation problem Multicollinearitas VIF test VIF below 10, tolerance above 0.5 Free of multicollinearitas problem Source: SPSS output Based on classical assumption test, this research is free from normality, heterocedasticity, autocorellation, and multicollinearity problem. table 4 hypotheses test Variables Coefficient t Significance Notes Constant OCI OPS DELAY -1.658 -0.186 0.001 0.021 -2.107 2.262 5.505 0.036 0.025 0.000 Ha Accepted Dependent Variable F Sig. R2 = Cost of Equity Capital = 0.000 = 0.150 (Source: SPSS output) Regression model of this research is: 𝐢𝑂𝐸𝐢 = βˆ’1.685 βˆ’ 0.186𝑂𝐢𝐼 + 0.001𝑂𝑃𝑆 + 0.021π·πΈπΏπ΄π‘Œ where: COEC OCI OPS DELAY = = = = Cost of equity capital Statement of other comprehensive income Other comprehensive income per share Days of reporting delay DISCUSSION Statement of other comprehensive income have regression coefficient value - 0.186, t value -2.107, significance value 0.036 (below 0.05). Hypotheses in this research accepted. Other comprehensive income statement reduce cost of equity capital. This result indicates that other comprehensive income have value relevance (Lin, Ramond and Casta, 2007; Pratiwi, Indriani and Midiastuty, 2012), have low information risk and cost, and decrease cost of equity capital. Statament of other comprehensive income shows the differences between fair value and historical value, as an impact of the use of fair value in measuring assets and liabilities. β€œFair values reflect the most current and complete expectation and estimation of the value of assets or liabilities, including the amounts, timing, and riskiness of the future cash flows attributable to assets or liabilities” (USA, CFA
  8. 8. Institute, 2010, p.2). The use of fair value, as the most relevant information, shows real economic activity measurement (USA, CFA Institute, 2010). Lin, Ramond and Casta (2007); Pratiwi, Indriani and Midiastuty (2012) stated that other comprehensive income have value relevance and affect stock price and return. Value relevance can reduce cost of equity capital (Francis et al. 2004). The more relevant financial statement, the less information risk (information asymmetric) in decision making, especially by investors. It also make investors get current value of companies less cost. Decreasing of information risk and cost will decrease expected return by investor (low risk makes low return). Low expected return means company will pay low cost of equity capital. Companies that stated other comprehensive income will pay low cost of equity capital. For example, company A stated other comprehensive income with surplus of fixed assets revaluation as the component, company B did not. Company B will pay more cost of equity capital than company A. Investor doesn’t know how much the current value of company B’s fixed assets because there is no stament of other comprehensive income. That asymetric information in company B make investor charge high expected return, because of high information risk. Investor also will pay more cost to make that asymetric information more allign. CONCLUSION Based on results, the conclusion of this research is other comprehensive income affect cost of equity capital negatively. It indicates other comprehensive income as a impact of the use of fair value reduce information risk (information asymetric) and help investors get information with low cost. This research have limitations. First, this research did not considered each component ability of other comprehensive income that can reduce cost of equity capital. Second, this research only used manufacture companies as sample, so the result can’t be generalized to all industries in population. Advices for similar subsequent research are (1) using consideration about each component ability of other comprehensive income that can reduce cost of equity capital; (2) use another industry, beside manufacture, as research sample; (3) as a new information in Indonesia, other comprehensive income can be tested with another variables, for example asymetric information, forecasting future performance, value relevance in stock or bond market, etc. REFERENCES BARTH, M. E. (2008) Global Financing Reporting: Implication for US Academics. The Accounting Review. 83 (5). p. 1159-1179. DE FRANCO, G., KOTHARI, S. P. and VERDI, R. S. (2011) The Benefits of Financial Statement Comparability. Journal of Accounting Research. 49 (4). p. 895- 931. FRANCIS, J., LAFOND, R., OLSSON, P. and SCHIPPER, K. (2004) Costs of Equity and Earnings Attributes. The Accounting Review. 79 (4). p. 967-1010. INDONESIA. Ikatan Akuntan Indonesia. (2009) Pernyataan standar akuntansi keuangan no. 1: Penyajian laporan keuangan. Jakarta: IAI.
  9. 9. INDONESIA. Ikatan Akuntan Indonesia. (2013) Pernyataan standar akuntansi keuangan no. 68: Pengukuran nilai wajar. Jakarta: IAI. LIN, S. W., RAMOND O. J. and CASTA J. F. (2007) Value relevance of comprehensive income and its components: Evidence from major European capital markets. in Europlace Institute of Finance Project: On the Relevance of Reporting Comprehensive Income under IAS / IFRS. 5th International Financial Research Forum. Paris, February 2007. Paris: EIF. MERINO, D. C., PLANS, C. M., and GUERRERO, N. O. (2014) Mandatory IFRS Adoption and the Cost of Equity Capital: Evidence from Spanish Firms. Intangible Capital. 10 (3). p. 562-583. ONWUCHEKWA, J. C. (2013) An Examination of the Audit Report Lag of Companies Quoted in the Nigeria Stock Exchange. The Journal of Business. 3 (9). p. 8-16 PATRO, A. and GUPTA, V. K. (2014) Impact of International Financial Reporting Standards on Cost of equity Capital for Asian Countries. International Journal of Accounting and Financial Reporting. 4 (2). p. 148-170 PRATIWI, E., INDRIANI, R. and MIDIASTUTY, P. P. (2012) Relevansi nilai informasi laporan keuangan dan komponen laba rugi komprehensif dalam menjelaskan harga dan return saham. in Prosiding Call For Paper & Seminar Nasional: Etika Bisnis: Kebutuhan atau Kewajiban?. Bandung, Friday 14th December 2012. Bandung: LPLA FPEB UPI. pp. 270-287 USA. CFA Institute. (2010) Supplement of comment letter to the FASB proposed accounting for financial instruments and revisions to the accounting for derivative instruments and hedging activities standards update: Fair value as the measurement basis for financial instruments. Charlottesville-Virginia: CFA Institute.
  10. 10. ATTACHMENT DESCRIPTIVE STATISTICS OUTPUT Descriptive Statistics N Minimum Maximum Mean Std. Deviation COEC 300 -1.50 86.48 .4963 5.82796 OCI 300 .00 1.00 .4400 .49722 OPS 300 -621.63 1289.70 16.1190 114.43522 TIMELINESS 300 55.00 151.00 86.8667 13.42646 Valid N (listwise) 300 NORMALITY TEST BEFORE TRIMMING OUTPUT One-Sample Kolmogorov-Smirnov Test Unstandardized Residual N 300 Normal Parametersa,b Mean 0E-7 Std. Deviation 5.73214172 Most Extreme Differences Absolute .351 Positive .351 Negative -.310 Kolmogorov-SmirnovZ 6.083 Asymp. Sig. (2-tailed) .000 a. Test distribution is Normal. b. Calculated from data. NORMALITY TEST AFTER TRIMMING (N=236) OUTPUT One-Sample Kolmogorov-Smirnov Test Unstandardized Residual N 236 Normal Parametersa,b Mean -.3153486 Std. Deviation .92724310 Most Extreme Differences Absolute .087 Positive .087 Negative -.081 Kolmogorov-SmirnovZ 1.338 Asymp. Sig. (2-tailed) .056 a. Test distribution is Normal. b. Calculated from data. HETEROCEDASTICITY TEST OUTPUT Coefficientsa Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) .661 .264 2.501 .013 OCI -.107 .071 -.100 -1.508 .133 OPS .000 .000 -.042 -.632 .528 TIMELINESS .003 .003 .056 .850 .396 a. DependentVariable:ABRES
  11. 11. MULTIOCOLLINEARITY, AUTOCORELLATION, REGRESSION TEST OUTPUT Model Summaryb Model R R Square Adjusted R Square Std. Error of the Estimate Durbin-Watson 1 .390a .152 .141 .66382 1.973 a. Predictors:(Constant), TIMELINESS, OPS, OCI b. DependentVariable:COEC ANOVAa Model Sum of Squares df Mean Square F Sig. 1 Regression 18.371 3 6.124 13.897 .000b Residual 102.233 232 .441 Total 120.604 235 a. DependentVariable:COEC b. Predictors:(Constant), TIMELINESS, OPS, OCI Coefficientsa Model Unstandardized Coefficients Standardized Coefficients t Sig. Collinearity Statistics B Std. Error Beta Tolerance VIF 1 (Constant) -1.658 .329 -5.039 .000 OCI -.186 .088 -.130 -2.107 .036 .968 1.034 OPS .001 .000 .138 2.262 .025 .978 1.022 TIMELINESS .021 .004 .335 5.505 .000 .988 1.012 a. DependentVariable:COEC

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