15 terms

Residual Income Valuation

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Residual Income Rationale
-RI explicitly deducts all capital costs
-Accounting income may overstate returns from perspective of equity investors
Economic value added (EVA)
Total Capital
NWC + fixed assets

= BV LT debt + BV Equity
Adjustments before calculating NOPAT/Invested Capital
1) Capitalize/amortize R&D and add back to earn.

2) Add back changes of strategic investments that generate returns

3) Eliminate deferred taxes, only consider cash taxes

4) Adjust nonrecurring items

5) Capitalize operating leases

6) Add LIFO reserve to invested capital, add back chg in LIFO reserve to NOPAT

7) Pension asset/liability issues

8) Goodwill
Market value added (MVA)
Residual Income (RI)
NI - equity charge

RI = (ROE - r) * Bt-1
Residual Income Model
Single Stage RI Model
Note: If ROE > r, 2nd term is positive, market value > BV, justified PB > 1
Tobin's Q
Multi Stage Residual Income Model
RI Persists at Current Level
Growth Immediately Drops to Zero
RI/(1+r)
Continuing Residual Income
Growth Declines to Long Run Level
Pt = Bt * forecasted P/B
Clean Surplus Relation
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