Sign up  |  Log in

Mendosa Case - Question about residual income calculation

Hi guys, I have a question with Mendosa case - Question 6.

The answer said “residual income in year 5 = 5.4*1.155”.

I don’t understand why we need to multiply 1.155, rather than 1.154?

The residual income in Year 1 = Book value of equity in year 0 * (ROE - r)

Please give me some hints. 

Thank you.

The best just got better. Schweser's upgraded content and redesigned study platform are exactly what you need to pass the Level III exam. Save 10% when you preorder a Premium Package for a limited time.

there are some wonderful people like S2000 to answer…but u have to ask very clearly…we are usually so engrossed in ques that we assume the reader is on the same ground :)

Hi,

The question is to calculate “the contribution that the terminal value of the residual income stream in 5 years will contribute to the current value of equity”.

As you have already got current year RI = Current NI - Begining BV of Equity capital x Cost of equity = 8 - (12,4% x 20,97) = 5,4

Take this current year to next 5 years = 5,4 x 1.155 as annual growth rate of RI is 15%

I thinks it’s pretty clear. Why 1.154?