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.

EXAMPLE: Calculating value with a multistage RI: JM is expecting ROE = 15% over next 5 years. Bo = $5.00 per share, pays
no dividends, and all earnings are reinvested. R = 10%. Forecasted earnings in years 1-5 = ROE * beginning BV. Calculate the
intrinsic value using a RI model, assuming that after five years, CRI falls to zero (i.e., ω = 0), (Assumption 2).

#2: RI drops immediately to Zero (ω = 0)

Fin calc:
CF0 = 5, C01 = 0.25, C02 = 0.29, C03 = 0.33, C04 = 0.38, C05 = 0.44,
I = 10, CPT → NPV = $6.25.

EXAMPLE: Suppose we now assume CRI after five years
remains constant at $0.44 (i.e., ω = 1), forever. New value?

#1: RI persists at the current level forever (ω = 1)

RI = RI = . . . = $0.44, and ω = 1 = $0.44
6
5
0.10

RI now persists at the same level forever, the
Why higher?
higher the ω, the higher the resulting value!