Page 34 - FINAL CFA II SLIDES JUNE 2019 DAY 8
P. 34
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.
EXAMPLE: Calculating value with a multistage residual income model (part 3): Now let’s make the more realistic
assumption that after Year 5, JM’s RI will decay over time to zero with a persistence factor of 0.4. New value?
Answer: Residual income begins to decline after Year 5, so the
terminal value in Year 4 includes the PV of Year 5 RI.
The intrinsic value today is:
BV + PV of years 1 through 4 RI + PV of terminal value in Year 4.
Notice that the more conservative assumption of a lower persistence factor reduces the intrinsic value of the stock because the
firm’s competitive advantage and economic profits eventually disappear.
EXAMPLE: Calculating value with a multistage residual income model (part 4): Suppose instead that at the end of Year 5
we assume that JM’s ROE falls to a long-run average level and the P/B ratio falls to 1.2. Calculate JM’s intrinsic value.
• Year 5 BV per share = $10.05 • Expected market price = $10.05 × 1.2 = $12.06.
