Page 30 - FINAL CFA II SLIDES JUNE 2019 DAY 8

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

Per the CRI Model,
V = B + (PV of interim high-growth RI) + (PV of continuing residual income)
0
0
Continuing residual income (CRI) is the portion expected over the long term (beyond the immediate short-term in which we
assume to be constant), depending on the fortunes of the industry, as well as on the sustainability of its competitive prospects.
The projected rate of fade over the life cycle of the firm is captured by a persistence factor, ω (0<ω<1):

Key assumptions are that RI is expected to:
1. Persist at its current level forever.
2. Drop immediately to zero. You must test each to
3. Decline over time as ROE falls to the cost of equity (in which case RI is eventually zero). determine which ω is
4. Decline to a long-run average level consistent with a mature industry. valid!

Persistence factor, ω (0<ω<1) depend on firm’s positioning 3 is often, most realistic, as
in relation to say Porter 5 forces, but other consideration, too: otherwise, firm will leave the
industry!

Higher persistence factors linked with: Lower persistence factors linked with:
• Low dividend payouts. • High return on equity.
• Historically high persistence in the industry • Significant levels of nonrecurring items.
• High accounting accruals.