- CFA Exams
- CFA Level I Exam
- Study Session 11. Equity Valuation (3)
- Reading 30. Residual Income Valuation
- Subject 1. Calculating residual income

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**CFA Practice Question**

An analyst observes that the current book value per share for ABC Corp is $7.58, and its dividend payout is 100%. The return on equity for the firm is expected to remain constant. If current earnings were reported at $0.95, and the required rate of return on equity is 11%, which of the following would best estimate the present value of residual in come on a per share basis?

B. $1.82

C. $8.63.

A. $1.06

B. $1.82

C. $8.63.

Correct Answer: A

Step 1. With a constant ROE and a zero retention rate, this company will have no earnings growth.

Step 2. Residual income = EPS - [(cost of equity)(Initial Book Value)] = $0.95 - [(.11)($7.58)] = $0.1162

Step 3. Present Value of Residual income (noting that it's a perpetuity): $0.1163/.11 = $1.06

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**User Contributed Comments**
6

User |
Comment |
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shipping |
this seems very hard... |

LloydBraun7 |
Other way: Come up with the value of the stock: (next dividend)/(req. return)......since g = 0. 0.95/0.11 = 8.64. This is the price per share. Substract the book value per share (7.58). You're left with residual value per share (1.06). |

aravinda |
Any idea why the net book value (which is total asset = total debt + total equity) is used in the formula... I was under the impression that the netbook vlaue is the total asset not only equity... |

Leese |
Thanks LloydBraun7, that's easier. |

Allen88 |
aravinda, I think the book value is the equity value. Which is why the required rate of return on equity is charged against this value. Hope this helps. |

davidt876 |
"book value per share" is understood to mean book value of equity. in the same way the market value of a company is understood to mean the market value of equity |