Page 34 - FINAL CFA II SLIDES JUNE 2019 DAY 8

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

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

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

#3: RI declines over time to zero (0<ω<1) = 0.4

EXAMPLE: Now assumption 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.

If per single-stage RI model, P = Bo + PV (of RI) ; then But we know P = B × (forecasted P/B ratio)
T
T
PV (of RI in year T) = P − B T
T

• Year 5 BV per share = $10.05 • Expected market price = $10.05 × 1.2 = $12.06.