book 6 test 2 am question 24 when the present value of expected RI is negative, the justified P/B based on fundamentals is less than one. Correct according to Schweser. they explian it: residual income valuation is related to P/B. when the present Value of the expected future residual income is negative, the justified P/B based on the fundamentals is less than 1. can someone make this easier to understand?
Justified P/B = (ROE - g) / (r - g) if ROE is less than r than P/B will be less than 1 So if RI is negative, that mean ROE is less than the required return, r…
in justified p/b why is the numerator (roe-g) not (roe-r)?
P=B(0) + [(ROE-r)/(r-g)]*B(0) Thus if your RI or the second portion of that equation is negative as a result of ROE
thanks you guys rock!!
I’m not entirely sure that I can explain why you have to subtract the g from ROE in the P/BV formula, its just a result of the algebraic derivation. I understood it when the book mapped it out, but then determined it would be easier just to remember it, the P/BV formula in my mind is pretty likely to show up if there’s an RI set, which there most likely will be, so its worth remembering.