Page 27 - FINAL CFA II SLIDES JUNE 2019 DAY 8

Residual income valuation model: READING 32: RESIDUAL INCOME VALUATION
Breaks stocks intrinsic value into 2 elements:
(1) current Be and (2) PV expected future RI: MODULE 32.2: RESIDUAL INCOME COMPUTATION

where:
B = current book value of equity
0
RI = E − (r × B t − 1 ) = (ROE − r) × B t − 1
t
t
r = required return on equity
ROE = expected return on new
investments (expected return on equity)

EXAMPLE: CPP has a required rate of return of 14%. The current BV is C$6.50. Earnings forecasts for 2019, 2020, and 2021
are C$1.10, C$1.00, and C$0.95, respectively. Dividends in 2019 and 2020 are forecasted to be C$0.50 and C$0.60,
respectively. The dividend in 2021 is a liquidating dividend, which means that CPP will pay out its entire BV in dividends and
cease doing business at the end of 2021. Calculate the value of CPP’s stock using the residual income model.

Fin calc:
CF = 6.50; C01 = 0.19; C02 = 0.01; C03 = –0.10; I = 14;
0
CPT → NPV = 6.61

Any differences with DDM/FCF Models?
Value is recognized earlier –it does not need terminal value (key in
14%*6.5
these others). But it uses BVe, which the others do not!
1.1-0.91
Will you rather have the certainty of BVe you know now or terminal
values you need to estimate and make assumptions about?
RI = E − (r × B t − 1 ) = (ROE − r) × B t − 1
t
t
(1.1/6.5 – 0.14 ) * 6.5) = 0.19