Residual Income - Wth!

CFA Level II
#1

Can anyone please explain me the continuing resdiual income calculation and the terminal valuation calculation for that… the time period is confusing me a lot.

Example: A company is expecting an ROE of 15% over each of the next 5 years. its currrent book value is $5 per share. Pays no dividend and all earning are reinvested . The required return on equity is 10%. Forecasted earnings in years 1 through 5 are equal to ROE times Beg. BV. Calculate the intrinsic value using residual income model, “assuming that after 5 years, continuing residual income falls to zero”

#2

It means there is no terminal value (if I understood correctly).

#3

WHy ?

#4

Because the problem tells you that :slight_smile:

Jk… what’s happening is after year 5 - the ROE declines to the cost of equity, hence no residual income.

Your calculated value would just equal current book value plus the present value of the 5 years that there was RI.

#5

What about the terminal value? The solution has discounted the fifth year RI - 4 periods. Didnt get that.