Hi,

I’m studying at Kaplan and come across the residual income approach to calculate company value.

The general formula is Residual Income = Net Income - Equity Charge

- Equity Charge = Beginning Book Value of Equity * Cost of Equity

The way that we calculate the Beg. BV of Equity is by using accounting equation Assets = Liabilities + Equity

The things I do not get it here is the calculation for Liabilities, which it is calculated based on market value of project, which is the future cash inflows.

In that sense, assuming my future cash inflows to be 10times higher than estimated, my liabilities would be far more high than my assets, which result me in net liabilities, where the amount of my borrowings to finance the initial investment is still the same.

Does this make sense? It simply means that the higher future cash inflow I have, the higher my liabilities I have.

Is there anything wrong or misconception here?