Is it just me, or are the RI models in equity totally confusing. I see how it’s closely related to DDM, but for some reason this subject just seems so conuluted to me!
Anyway, just wanted to bitch. Happy studies.
VaR_99,
I think it is an easy topic once you understand the basics. I will try to give some pointers, and i hope that it helps.
First - what is RI?
When you look at NI, you can see that it includes the charges or return that debt providers (say bond holders) required in the form of interest expense. However, there is no such thing for equity holders (shareholders). Shareholders require return on equity, which we have seen in other readings being referred as re. But, shareholders are not coming to the company and saying “ok, its time for my return as it is the case with bond holders”. So, my point is looking at NI is not a good measure for shareholder’s return. This is where RI comes in and explicitly proivdes this info.
In short, RI is the return above and beyond the NI after taking out returns needed by the equity holders. So, what is the return needed by the shareholders in dollar terms (also called Equity Charge)
Let’s say you and your friends provided $100 to Company X and would like to get a 10% return on it (re = 10%). So, this is your equity - Shareholders equity or Book Value of the company. For simplicity, let’s assume there are no other items in the book value. And let’s say company made $50 as NI this year. Then, equity charge that you and your friends implicitly need is $100 *10% (BV * re). So, RI = 50-10 = $40.
Sorry, if you were looking for something more deeper. Let’s us know.
Yeh RI is the topic I’ve spent the most time on. It just seems to go over my head a little. I know what they’re trying to do but it’s a little much for me to process. you’re not alone bud 