Residual Income Valuation

Question 1

Residual income

Answer 1

Economic profit; the net income of a firm less a charge that measures stockholders’ opportunity cost of capital; explicitly deducts all capital costs

Question 2

Economic value added (EVA)

Answer 2

Measures the value added for shareholders by management during a given year
EVA = NOPAT - (WACCtotal capital)
= [EBIT * (1-t)] - $WACC
Total capital = net working capital + net fixed assets = book value of long-term debt + book value of equity
**use beginning of year total capital

Question 3

Market value added (MVA)

Answer 3

Difference between the market value of a firm’s long-term debt and equity and the book value of invested capital supplied by investors. Measures the value created by management’s decisions since the firm’s inception
MVA = market value - total capital
*** use end of year total capital (the same point at which market value is determined)

Question 4

Forecasting residual income

Answer 4

RI/share at time t = EPSt - (rBVPSt-1) = (ROE-r)BVPSt-1

Question 5

Single-stage RI valuation model

Answer 5

Vo = Bo + [(ROE-r)*Bo] / (r-g)

Question 6

Multistage RI model

Answer 6

Vo = Bo + PV of interim high-growth RI + PV of continuing RI