{"id":30100,"date":"2023-01-02T09:52:37","date_gmt":"2023-01-02T09:52:37","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=30100"},"modified":"2026-01-07T18:42:44","modified_gmt":"2026-01-07T18:42:44","slug":"fundamental-determinants-of-residual-income-2","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/equity-valuation\/fundamental-determinants-of-residual-income-2\/","title":{"rendered":"Fundamental Determinants of Residual Income"},"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\": \"Fundamental drivers of residual income\",\r\n    \"text\": \"Which of the following is least likely a fundamental driver of residual income?\\n\\nA. Constant growth in earnings.\\n\\nB. Constant growth in revenues.\\n\\nC. Constant growth in dividends.\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"B. Constant growth in revenues.\\n\\nConstant growth in revenues is not a fundamental driver of residual income, as residual income is primarily driven by earnings and dividends. While revenues are important, they do not directly impact the calculation of residual income in the same way as earnings and dividends.\\n\\nA is incorrect because constant growth in earnings is a key driver of residual income.\\n\\nC is incorrect because constant growth in dividends is also a fundamental driver of residual income.\"\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\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<div class=\"cta-button\">\r\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\" \r\n     class=\"button small-button\" \r\n     target=\"_blank\" \r\n     rel=\"noopener noreferrer\">\r\n    Want to practice residual income valuation with CFA\u00ae-style questions? Start your free trial.\r\n  <\/a>\r\n<\/div>\r\n\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 (l) Evaluate whether a stock is overvalued, fairly valued, or undervalued based on a residual income model.<\/em><\/p>\r\n<div class=\"cta-button\">\r\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\" \r\n     class=\"button large-button\" \r\n     target=\"_blank\" \r\n     rel=\"noopener noreferrer\">\r\n    Start Free Trial \u2192<br>\r\n    <span style=\"font-weight: normal;\">\r\n      Practice residual income problems with full solutions and detailed explanations\r\n    <\/span>\r\n  <\/a>\r\n<\/div>\r\n\r\n","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: $$\\text{V}_{0}=\\text{B}_{0}+\\frac{\\text{ROE}-\\text{r}}{\\text{r}-\\text{g}}\\text{B}_{0}$$ Want to practice residual&#8230;<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,401],"tags":[],"class_list":["post-30100","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Fundamental Determinants of Residual Income | CFA L2<\/title>\n<meta name=\"description\" content=\"Review the key drivers of residual income, including growth in earnings and dividends, and how 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