Equity Asset Valuation, Second Edition

CHAPTER 5

RESIDUAL INCOME VALUATION

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following :

• Calculate and interpret residual income and related measures (e.g., economic value added and market value added).

• Discuss the use of residual income models.

• Calculate future values of residual income given current book value, earnings growth estimates, and an assumed dividend payout ratio.

• Calculate the intrinsic value of a share of common stock using the residual income model.

• Discuss the fundamental determinants or drivers of residual income.

• Explain the relationship between residual income valuation and the justified price-to-book ratio based on forecasted fundamentals.

• Calculate and interpret the intrinsic value of a share of common stock using a single-stage (constant-growth) residual income model.

• Calculate an implied growth rate in residual income given the market price-to-book ratio and an estimate of the required rate of return on equity.

• Explain continuing residual income and list the common assumptions regarding continuing residual income.

• Justify an estimate of continuing residual income at the forecast horizon given company and industry prospects.

• Calculate and interpret the intrinsic value of a share of common stock using a multistage residual income model, given the required rate of return, forecasted earnings per share over a finite horizon, and forecasted continuing residual earnings.

• Explain the relationship ...