Page 32 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 32.h: Explain continuing residual income (CRI) READING 32: RESIDUAL INCOME VALUATION
and justify an estimate of continuing residual
income at the forecast horizon, given company and MODULE 32.4: CONTINUING RESIDUAL INCOME
industry prospects.

Per the CRI,
V = B + (PV of interim high-growth RI) + (PV of continuing residual income)
0
0

Assumption #1: Residual Income
Persists at the Current Level
Forever (ω = 1)

Assumption #2: Residual Income
Drops Immediately to Zero (ω = 0)

Assumption #3: Residual Income
Declines Over Time to Zero (0<ω<1)

Assumption #4: Residual Income Per single-stage residual income model, MV (Price, P) = BV (Book Value, B) + PV of RI
Declines to Long-Run Level in Therefore, at any point in time (T), PV of continuing residual income in year T = P − B
Mature Industry (does not rely on the T T
formula or ω) Given a forecasted P/B ratio and BV at the end of the year T, the value of the stock is:
P = B × (forecasted price-to-book ratio)
T
T