How is the residual income model appripriate when the expected free cash flows are supposed to be negative for the future?
The bulk of the value in the residual income model comes from the current book value, not from future cash flows.
But don’t negative cash flows imply negative operating earnings (as per the FCF formula), and if we have negative operating earnings that would mess up the RI calculation?
So you can always have a positive net earnings and a negative free cash flow. You know a company’s capex and working cap can eat into a companysc profits leading to a negative fcf. Another thing to consider one time income. If its contributing to a huge portion of a companysc net income, that will be negated while calculating fcf, again leading to a possible negative fcf.
Hope this helps.
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Even if you have negative earnings, there’s no reason it should mess up the RI calculation.
What makes you think that it would?
Point ! Majority of the value comes from the book value anyways.