Residual Income Method: Continuing residual income

Hi, I stumbled over a problem regarding the discounting of the “continuing residual income”. Let’s assume the firm’s residual income in period 4 is 0.45 and is expected to fade with omega 0.5 thereafter, i.e. from period 5 on. How come that you calculate the continuing residual income and discount it to period 3, i.e. you add the PV of the continuing residual income not to the residual income of period 4 but 3 according to the formula provided in the CFA curriculum. Isn’t the result that you simply ignore the RI of period 4 or is the persistence factor (omega) only “active” from period 5 on? I am just wondering because if you calculate the terminal value, which can be interpreted as the continuing residual income in the RI model, you would discount it to period 4 (in my example) and not 3. Thanks for your help!

Does anybody have a clue?

Does anybody know?

just like GGM which uses Div1/(r-g) to get P0. Here it is using RI(t) and assumption of omega and r to get continueing value V(t-1). Hope it help.

yeah…at this stage I would just make note of how they do it then move along

because x = RI(4)/(1+r-omega) is the value AT year 4. i would discount x to period 3