{"id":20944,"date":"2021-09-06T06:53:16","date_gmt":"2021-09-06T06:53:16","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=20944"},"modified":"2025-12-12T11:30:05","modified_gmt":"2025-12-12T11:30:05","slug":"use-of-residual-income-models","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/","title":{"rendered":"Use of Residual Income Models"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"What is the minimum number of fields the conglomerate needs to disclose with full details?\",\r\n    \"text\": \"A conglomerate owns subsidiaries working in the following segments:\\n\\nSegment\\n% Participation in the conglomerate\u2019s revenue\\nMining 20%\\nConsumer care products 30%\\nMedia 25%\\nElectronics 10%\\nShipping 7%\\nConstruction 8%\\n\\nWhat is the minimum number of fields the conglomerate needs to disclose with full details?\\n\\nA. 3\\nB. 4\\nC. 5\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is B.\\n\\nThe conglomerate needs to disclose the full details fields of all the segments which contribute to at least 75% of its revenue. The condition applies to the 3 segments which are mining, consumer care products, and media.\\n\\nIn addition to what was previously mentioned, the company needs to disclose full details of segments contributing to 10% or more to its total revenue. This, therefore, requires us to add the electronics segment.\\n\\nThese disclosure criteria require detailed disclosure of mining, consumer products, media, and electronics, which sums up to 4 segments.\"\r\n    },\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Option A is incorrect because only 3 segments contribute to at least 75% of total revenue, but the electronics segment must also be disclosed because it contributes 10% or more to total revenue, which brings the total to 4 segments.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Option C is incorrect because 5 segments do not meet the disclosure criteria, only 4 segments require detailed disclosure.\"\r\n      }\r\n    ]\r\n  }\r\n}\r\n<\/script>\r\n\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/PBa-kWaY4gs\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><\/iframe><\/p>\r\n<p>A company with positive residual income\u2014generating more income than its cost of capital\u2014is creating value. A company with negative residual income is destroying value. A higher residual income is associated with a higher valuation.<\/p>\r\n<p>Residual income models have been used to value individual stocks and equity indices. The residual income model has also been used to measure the impairment of goodwill.<\/p>\r\n<p>Residual income is also referred to as economic profit\/abnormal earnings because of its estimate of the company&#8217;s profit after deducting the cost of all capital.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Which of the following statements is the most accurate regarding residual income?<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>A company with positive residual income is generating more income than its cost of capital.<\/li>\r\n\t<li>A company with positive residual income is only generating enough income to cover its cost of debt.<\/li>\r\n\t<li>A company with positive residual income should expect its share price to be lower than its book value.<\/li>\r\n<\/ol>\r\n<h3>Solution<\/h3>\r\n<p><strong>The correct answer is A.\u00a0<\/strong><\/p>\r\n<p>A company with positive residual income generates more income than its cost of capital for both debt and equity.\u00a0 Residual income is calculated by deducting a company\u2019s cost of capital. If it is positive, then the company is generating more income than its cost of both debt and equity.<\/p>\r\n<p><strong>B is incorrect.\u00a0<\/strong>A company with positive residual income is generating enough income to cover both its cost of debt and cost of equity.<\/p>\r\n<p><strong>C is incorrect.\u00a0<\/strong>A company with positive residual income should expect its share price to be higher than its book value because it is generating value.<\/p>\r\n<\/blockquote>\r\n<p>Reading 26: Residual Income Valuation<\/p>\r\n<p><em>LOS 26 (b) Describe the uses of residual income models.<\/em><\/p>\r\n","protected":false},"excerpt":{"rendered":"<p>\ufeff\ufeff A company with positive residual income\u2014generating more income than its cost of capital\u2014is 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&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,401],"tags":[216,402,492,493],"class_list":["post-20944","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","tag-cfa-level-2","tag-equity-valuation","tag-reading-30-residual-income-valuation","tag-use-of-residual-income-models","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Use of Residual Income Models - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"Residual income in finance: positive residual income means generating more income than cost of capital, creating value and higher valuation.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Use of Residual Income Models - CFA, FRM, and Actuarial Exams Study Notes\" \/>\n<meta property=\"og:description\" content=\"Residual income in finance: positive residual income means generating more income than cost of capital, creating value and higher valuation.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/\" \/>\n<meta property=\"og:site_name\" content=\"CFA, FRM, and Actuarial Exams Study Notes\" \/>\n<meta property=\"article:published_time\" content=\"2021-09-06T06:53:16+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2025-12-12T11:30:05+00:00\" \/>\n<meta name=\"author\" content=\"Irene R\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" content=\"Irene R\" \/>\n\t<meta name=\"twitter:label2\" content=\"Est. reading time\" \/>\n\t<meta name=\"twitter:data2\" content=\"1 minute\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"Article\",\"@id\":\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/#article\",\"isPartOf\":{\"@id\":\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/\"},\"author\":{\"name\":\"Irene R\",\"@id\":\"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/7002f30d8f174958802c1c30b167eaf5\"},\"headline\":\"Use of Residual Income Models\",\"datePublished\":\"2021-09-06T06:53:16+00:00\",\"dateModified\":\"2025-12-12T11:30:05+00:00\",\"mainEntityOfPage\":{\"@id\":\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/\"},\"wordCount\":277,\"keywords\":[\"CFA-level-2\",\"Equity Valuation\",\"Reading 30: Residual Income Valuation\",\"Use of Residual Income Models\"],\"articleSection\":[\"CFA Level II Study Notes\",\"Equity Valuation\"],\"inLanguage\":\"en-US\"},{\"@type\":\"WebPage\",\"@id\":\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/\",\"url\":\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/\",\"name\":\"Use of Residual Income Models - CFA, FRM, and Actuarial Exams Study Notes\",\"isPartOf\":{\"@id\":\"https:\/\/analystprep.com\/study-notes\/#website\"},\"datePublished\":\"2021-09-06T06:53:16+00:00\",\"dateModified\":\"2025-12-12T11:30:05+00:00\",\"author\":{\"@id\":\"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/7002f30d8f174958802c1c30b167eaf5\"},\"description\":\"Residual income in finance: positive residual income means generating more income than cost of capital, creating value and higher valuation.\",\"breadcrumb\":{\"@id\":\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/#breadcrumb\"},\"inLanguage\":\"en-US\",\"potentialAction\":[{\"@type\":\"ReadAction\",\"target\":[\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/\"]}]},{\"@type\":\"BreadcrumbList\",\"@id\":\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/#breadcrumb\",\"itemListElement\":[{\"@type\":\"ListItem\",\"position\":1,\"name\":\"Home\",\"item\":\"https:\/\/analystprep.com\/study-notes\/\"},{\"@type\":\"ListItem\",\"position\":2,\"name\":\"Use of Residual Income Models\"}]},{\"@type\":\"WebSite\",\"@id\":\"https:\/\/analystprep.com\/study-notes\/#website\",\"url\":\"https:\/\/analystprep.com\/study-notes\/\",\"name\":\"CFA, FRM, and Actuarial Exams Study Notes\",\"description\":\"Question Bank and Study Notes for the CFA, FRM, and Actuarial exams\",\"potentialAction\":[{\"@type\":\"SearchAction\",\"target\":{\"@type\":\"EntryPoint\",\"urlTemplate\":\"https:\/\/analystprep.com\/study-notes\/?s={search_term_string}\"},\"query-input\":{\"@type\":\"PropertyValueSpecification\",\"valueRequired\":true,\"valueName\":\"search_term_string\"}}],\"inLanguage\":\"en-US\"},{\"@type\":\"Person\",\"@id\":\"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/7002f30d8f174958802c1c30b167eaf5\",\"name\":\"Irene R\",\"image\":{\"@type\":\"ImageObject\",\"inLanguage\":\"en-US\",\"@id\":\"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/image\/\",\"url\":\"https:\/\/secure.gravatar.com\/avatar\/33caf1e1bcb63ee970b36351f165c7bc714b19614993ab9c2c8bf36273b7df48?s=96&d=mm&r=g\",\"contentUrl\":\"https:\/\/secure.gravatar.com\/avatar\/33caf1e1bcb63ee970b36351f165c7bc714b19614993ab9c2c8bf36273b7df48?s=96&d=mm&r=g\",\"caption\":\"Irene R\"},\"url\":\"https:\/\/analystprep.com\/study-notes\/author\/irene\/\"}]}<\/script>\n<meta property=\"og:video\" content=\"https:\/\/www.youtube.com\/embed\/PBa-kWaY4gs\" \/>\n<meta property=\"og:video:type\" content=\"text\/html\" \/>\n<meta property=\"og:video:duration\" content=\"2803\" \/>\n<meta property=\"og:video:width\" content=\"480\" \/>\n<meta property=\"og:video:height\" content=\"270\" \/>\n<meta property=\"ya:ovs:adult\" content=\"false\" \/>\n<meta property=\"ya:ovs:upload_date\" content=\"2021-09-06T06:53:16+00:00\" \/>\n<meta property=\"ya:ovs:allow_embed\" content=\"true\" \/>\n<!-- \/ Yoast SEO plugin. -->","yoast_head_json":{"title":"Use of Residual Income Models - CFA, FRM, and Actuarial Exams Study Notes","description":"Residual income in finance: positive residual income means generating more income than cost of capital, creating value and higher valuation.","robots":{"index":"index","follow":"follow","max-snippet":"max-snippet:-1","max-image-preview":"max-image-preview:large","max-video-preview":"max-video-preview:-1"},"canonical":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/","og_locale":"en_US","og_type":"article","og_title":"Use of Residual Income Models - CFA, FRM, and Actuarial Exams Study Notes","og_description":"Residual income in finance: positive residual income means generating more income than cost of capital, creating value and higher valuation.","og_url":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/","og_site_name":"CFA, FRM, and Actuarial Exams Study Notes","article_published_time":"2021-09-06T06:53:16+00:00","article_modified_time":"2025-12-12T11:30:05+00:00","author":"Irene R","twitter_card":"summary_large_image","twitter_misc":{"Written by":"Irene R","Est. reading time":"1 minute"},"schema":{"@context":"https:\/\/schema.org","@graph":[{"@type":"Article","@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/#article","isPartOf":{"@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/"},"author":{"name":"Irene R","@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/7002f30d8f174958802c1c30b167eaf5"},"headline":"Use of Residual Income Models","datePublished":"2021-09-06T06:53:16+00:00","dateModified":"2025-12-12T11:30:05+00:00","mainEntityOfPage":{"@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/"},"wordCount":277,"keywords":["CFA-level-2","Equity Valuation","Reading 30: Residual Income Valuation","Use of Residual Income Models"],"articleSection":["CFA Level II Study Notes","Equity Valuation"],"inLanguage":"en-US"},{"@type":"WebPage","@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/","url":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/","name":"Use of Residual Income Models - CFA, FRM, and Actuarial Exams Study Notes","isPartOf":{"@id":"https:\/\/analystprep.com\/study-notes\/#website"},"datePublished":"2021-09-06T06:53:16+00:00","dateModified":"2025-12-12T11:30:05+00:00","author":{"@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/7002f30d8f174958802c1c30b167eaf5"},"description":"Residual income in finance: positive residual income means generating more income than cost of capital, creating value and higher valuation.","breadcrumb":{"@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/#breadcrumb"},"inLanguage":"en-US","potentialAction":[{"@type":"ReadAction","target":["https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/"]}]},{"@type":"BreadcrumbList","@id":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/use-of-residual-income-models\/#breadcrumb","itemListElement":[{"@type":"ListItem","position":1,"name":"Home","item":"https:\/\/analystprep.com\/study-notes\/"},{"@type":"ListItem","position":2,"name":"Use of Residual Income Models"}]},{"@type":"WebSite","@id":"https:\/\/analystprep.com\/study-notes\/#website","url":"https:\/\/analystprep.com\/study-notes\/","name":"CFA, FRM, and Actuarial Exams Study Notes","description":"Question Bank and Study Notes for the CFA, FRM, and Actuarial exams","potentialAction":[{"@type":"SearchAction","target":{"@type":"EntryPoint","urlTemplate":"https:\/\/analystprep.com\/study-notes\/?s={search_term_string}"},"query-input":{"@type":"PropertyValueSpecification","valueRequired":true,"valueName":"search_term_string"}}],"inLanguage":"en-US"},{"@type":"Person","@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/7002f30d8f174958802c1c30b167eaf5","name":"Irene R","image":{"@type":"ImageObject","inLanguage":"en-US","@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/image\/","url":"https:\/\/secure.gravatar.com\/avatar\/33caf1e1bcb63ee970b36351f165c7bc714b19614993ab9c2c8bf36273b7df48?s=96&d=mm&r=g","contentUrl":"https:\/\/secure.gravatar.com\/avatar\/33caf1e1bcb63ee970b36351f165c7bc714b19614993ab9c2c8bf36273b7df48?s=96&d=mm&r=g","caption":"Irene R"},"url":"https:\/\/analystprep.com\/study-notes\/author\/irene\/"}]},"og_video":"https:\/\/www.youtube.com\/embed\/PBa-kWaY4gs","og_video_type":"text\/html","og_video_duration":"2803","og_video_width":"480","og_video_height":"270","ya_ovs_adult":"false","ya_ovs_upload_date":"2021-09-06T06:53:16+00:00","ya_ovs_allow_embed":"true"},"_links":{"self":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/20944","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/users\/5"}],"replies":[{"embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/comments?post=20944"}],"version-history":[{"count":7,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/20944\/revisions"}],"predecessor-version":[{"id":41437,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/20944\/revisions\/41437"}],"wp:attachment":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/media?parent=20944"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/categories?post=20944"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/tags?post=20944"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}