Residual income

CFA Level II
#1

“Residual income makes no assumptions about future earnings and the justified P/B is directly related to future expected residual income.”

I understand the second component of this equation. however I do not understand the first component. How does the residual income not make any assumptions about future earnings. How would residual income be computed in the future?

Thanks,

#2

well I don’t understand either because RI = net income - equity charge so to forecast net income you have to assume a growth rate for net income.

Even if you go about it like this… RIt = (ROE-r)*BVt0 you still have to assume that either ROE(net inc/common) doesn’t change or that it does at a specific growth rate

#3

I would imagine you would have to be given different assumptions for ROE in the future and then discount the RI estimates for each year back to PV.