Page 26 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 32.b: Describe the uses of READING 32: RESIDUAL INCOME VALUATION
residual income models.
MODULE 32.1: RESIDUAL INCOME DEFINED

• Measurement of managerial effectiveness and executive compensation.
• For the exams however, our interest is valuation applications of these models, including measure of goodwill impairment.

Residual income forecast residual: where:
RI = E − (r × B t − 1 ) = (ROE − r) × B t − 1
t
t
RI = residual income per share in year t
t
EXAMPLE: LK was assigned the task of forecasting the E = expected EPS for year t
t
residual income for Delilah Cosmetics, Inc. over the next r = required return on equity
= book value per share in year t − 1
B
t − 1
two years. To accomplish this task, Kraft assembled the ROE = expected return on new investments (expected return on equity)
information provided in the following figure. Kraft used a
required rate of return of 11%. Forecast Delilah’s
residual income for 2019 and 2020.