{"id":21037,"date":"2021-09-07T15:49:28","date_gmt":"2021-09-07T15:49:28","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=21037"},"modified":"2026-06-24T19:52:11","modified_gmt":"2026-06-24T19:52:11","slug":"fundamental-determinants-of-residual-income","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/fundamental-determinants-of-residual-income\/","title":{"rendered":"Fundamental Determinants of Residual Income (2022)"},"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\": \"Which of the following is least likely a fundamental driver of residual income?\",\r\n    \"answerCount\": 3,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is B. Constant growth in revenues. Residual income is fundamentally driven by factors such as earnings growth and dividend growth, which directly affect shareholder value and profitability. Revenue growth alone does not necessarily translate into residual income because it does not account for costs, profitability, or the required return on equity.\"\r\n    },\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Constant growth in earnings.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Constant growth in revenues.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Constant growth in dividends.\"\r\n      }\r\n    ]\r\n  }\r\n}\r\n<\/script>\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\r\n<p>The fundamental drivers of residual income can be recognized by assuming a constant growth in dividends and earnings.<\/p>\r\n<p>Assuming constant growth, a stock\u2019s intrinsic value under the residual income model, can be expressed as:<\/p>\r\n<p>$$\\text{V}_{0}=\\text{B}_{0}+\\frac{\\text{ROE}-\\text{r}}{\\text{r}-\\text{g}}\\text{B}_{0}$$<\/p>\r\n<p>If the return on equity equals the required return on equity, the share&#8217;s intrinsic value will be equal to the book value. If the return on equity is greater than the required return on equity, the stock&#8217;s intrinsic value will be higher than the book value, and the justified P\/B ratio will be greater than 1. If the return on equity is less than the required return on equity, the stock&#8217;s intrinsic value will be less than the book value, and the justified P\/B ratio will be less than 1.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Which of the following is <em>least likely<\/em> a fundamental driver of residual income?<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>Constant growth in earnings.<\/li>\r\n\t<li>Constant growth in revenues.<\/li>\r\n\t<li>Constant growth in dividends.<\/li>\r\n<\/ol>\r\n<h3>Solution<\/h3>\r\n<p><strong>The correct answer is B.\u00a0<\/strong><\/p>\r\n<p>Constant growth in revenues is not a fundamental driver of residual income.<\/p>\r\n<p><strong>A is incorrect.\u00a0<\/strong>Constant growth in earnings is a fundamental driver of residual income.<\/p>\r\n<p><strong>C is incorrect.\u00a0<\/strong>Constant growth in revenues is a fundamental driver of residual income.<\/p>\r\n<\/blockquote>\r\n<p>Reading 26: Residual Income Valuation<\/p>\r\n<p><em>LOS 26 (d) Explain fundamental determinants of residual income.<\/em><\/p>\r\n\r\n<div style=\"text-align: center; margin: 30px 0;\"><a style=\"display: inline-flex; align-items: center; justify-content: center; padding: 12px 26px; border-radius: 9999px; background: #1e5bd8; color: #ffffff; font-weight: bold; text-decoration: none;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a> <p style=\"margin-top: 12px; font-size: 16px; line-height: 1.5;\">Review the fundamental determinants of residual income with CFA Level 2 study notes, practice questions, mock exams, and video lessons designed to strengthen your exam preparation.<\/p>\r\n <\/div>","protected":false},"excerpt":{"rendered":"<p>\ufeff\ufeff The fundamental drivers of residual income can be recognized by assuming a constant growth in dividends and earnings. Assuming constant growth, a stock\u2019s 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&#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":[216,402,495,492],"class_list":["post-21037","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","tag-cfa-level-2","tag-equity-valuation","tag-fundamental-determinants-of-residual-income","tag-reading-30-residual-income-valuation","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Determinants of Residual Income | CFA Level 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