question from equity

[Pasgon]

Statement 3—Raman : I agree. The residual income (RI) model, also called the “excess earnings method,” does not have the same weakness as the FCFE approach because residual income is an estimate of the profit of the company after deducting the cost of all capital: debt and equity. Furthermore, it makes no assumptions about future earnings and the justified P/B is directly related to expected future residual income.

I needddd your helpppp!

as far as i understand, FCFE model uses the requried rate of equity as discount factor. As said so, it is appropriate to define that RI( which also use Rr as discount) is not after deducttion of the cost of all debt and equity, but only equity?

Thank you guys,

[300hoursoverandovera]

@Pasgon

as far as i understand, FCFE model uses the requried rate of equity as discount factor. As said so, it is appropriate to define that RI( which also use Rr as discount) is not after deducttion of the cost of all debt and equity, but only equity?

Thank you guys,

The drawback shown in the RI model is that it assumes that interest cost reflects the cost of debt capital.

That is also considered as a disadvantage to the model.

Interest expense will have to be deducted to arrive at NI. Remember our RI is based on the Earnings for the year( NI) over the excess of equity charge

This is why we say that it subtracts both cost of equity and debt capital.