Hey guys,
I’ve been calculating Justified ROE as (ROE - r)/(r-g) this entire time and yesterday on the mock exam the answer that was given was calculated as (ROE - g)/(r - g). Is there a time when I should be using this formula instead? It was literally driving me insane.
You mean justified P/B ratio?
I do, yes. Sorry.
It’s always ROE-g / r-g
If ROE = r, then it trades at 1 PB.
It looks like you were originally thinking of
[(ROE-r)*Bo]/(r-g)
Which is used in the residual income model. *Bo= Beginning BV
^ James, believe you need to add one more piece to that formula for RI model.
P = B0 + [(ROE-r)*Bo]/(r-g)
which can then be re-arranged to get to:
P/Bo = 1 + [(ROE-r)]/(r-g) in the RI model… (which is where fluffhead probably got mixed up).
Ah, thats it! Thanks everyone.
His version is MVA I believe.
What’s a fluffhead, anyway?