In practice problem 15 from the curriculum,
Use the following inputs and the finite horizon form of the residual income model to compute the value of Southern Trust Bank (STB) shares as of 31 December 2007:
- ROE will continue at 15 percent for the next five years (and 10 percent thereafter) with all earnings reinvested (no dividends paid).
- Cost of equity equals 10 percent.
- B0 = $10 per share (at year-end 2007).
- Premium over book value at the end of five years will be 20 percent.
In the answer we multiply premium to beginning book value of the sixth year and discount it back to 5 years, but the formula is
(PT−BT)+RIT/(1+r)T so shouldn’t we add premium to RI of 6th year to find the value of year 5 and then add it to RI of 5th year?