Implied Growth Rate in Residual Income
The single-stage residual income equation can be rearranged to calculate the growth implied by the current market price. The current market price would be assumed to equal the stock’s intrinsic value. The intrinsic value is assumed to be the…
Single-Stage Residual Income Valuation
Single-Stage Residual Income Valuation The single-stage residual income (constant-growth) model assumes that a firm has a constant return on equity and constant earnings growth rate through time. $$\text{V}_{0}=\text{B}_{0}+\frac{\text{ROE}-\text{r}}{\text{r}-\text{g}}\text{B}_{0}$$ Example: Using a Single-stage Residual Income Model A company’s current book…
Residual Income Valuation vs. Justified P/B Ratio
Residual income models can be used to estimate justified price multiples. From the justified P/B ratio based on fundamentals: $$\frac{\text{P}_{0}}{\text{B}_{0}}=\frac{\text{ROE}-\text{g}}{\text{r}-\text{g}}$$ Which is mathematically equivalent to: $$\frac{\text{P}_{0}}{\text{B}_{0}}=1+\frac{\text{ROE}-\text{r}}{\text{r}-\text{g}}$$ The approximated value of a share is the book value per share plus…
Fundamental Determinants of Residual Income (2022)
The fundamental drivers of residual income can be recognized by assuming a constant growth in dividends and earnings. Assuming constant growth, a stock’s intrinsic value under the residual income model, can be expressed as: $$\text{V}_{0}=\text{B}_{0}+\frac{\text{ROE}-\text{r}}{\text{r}-\text{g}}\text{B}_{0}$$ If the return on…
Effects of Demographics, Immigration, and Labor Force Participation on the Rate and Sustainability of Economic Growth
Labor Supply The production function shows that economic growth is mainly affected by increased labor and capital. The size of Labor is measured using the total number of hours available for work. The labor force is the proportion of the…
Effect of Natural Resources on Economic Growth
A simple form of the production function, which concentrated on labor and capital inputs, was used in the previous reading. The production function can be extended to include other factors of production, such as: Human capital (H). Raw materials (N)….
Residual Income Model
The residual income model analyzes the intrinsic value of equity as the sum of: The current book value of equity; and The present value of expected future residual income. Residual income is computed as net income minus an equity…
Use of Residual Income Models
A company with positive residual income—generating more income than its cost of capital—is creating value. A company with negative residual income is destroying value. A higher residual income is associated with a higher valuation. Residual income models have been…
Residual Income
Residual income deducts a charge for equity capital to determine whether the company is earning a return above the opportunity costs for equity investors. Residual income is equivalent to economic profit. It is calculated as: $$\begin{align*}\text{Residual income}&=\text{Net income}-\text{Equity charge}\\…
Study Notes for CFA® Level II – Economics – offered by AnalystPrep
Reading 8: Currency Exchange Rates: Understanding Equilibrium Value -a. Calculate and interpret the bid-offer spread on a spot or forward currency quotation and describe the factors that affect the bid-offer spread; -b. Identify a triangular arbitrage opportunity and calculate the…
