Page 29 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 32.f: Calculate and interpret the intrinsic value
of a common stock using single-stage (constant- READING 32: RESIDUAL INCOME VALUATION
growth) and multistage residual income models.
MODULE 32.3: CONSTANT GROWTH MODEL FOR RI

EXAMPLE: WAR has a BV of $23.00 per share. Its ROE (new investments) = 14%, and its r = 12%. The DPR = 60%.
Calculate the value of the shares using a single-stage RI model and the PV of expected economic profits.

g = retention ratio × ROE
= (1 − 0.6) × 0.14 = 0.056 = 5.6%

PV expected economic profits is $7.19.

EXAMPLE: WAR valuation with Gordon growth model: Use the information in the previous example to calculate the value of
WAR common stock using the Gordon growth model.

Earnings in Year 1 (E ) = beginning BV * ROE: E = $23.00 × 0.14 = $3.22.
1
1
With DPR= 60%, D = $3.22 (0.6) = $1.932.
1

LOS 32.g: Calculate the implied growth rate in RI, given the market price-to-book ratio and an estimate of the required
rate of return on equity.

EXAMPLE: Calculating implied growth rate: You are considering the purchase of TT which
has a P/B ratio of 2.50. ROE is expected to be 13%, current book value per share is €8.00,
and the cost of equity is 11%. Calculate the growth rate implied by the current P/B ratio.

The P/B ratio of 2.50 and the current book value per share
of €8.00 imply a current market price of €20.00(8 × 2.50).