C4
Residual Income Lab
Start from book value and add what the company earns above the charge for its equity. This model works for banks and insurers as well.
Learning focus: A company creates value only by earning more than its cost of equity, so residual income recognizes value earlier than dividends do, and relies less on the terminal value.
Case file
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After the forecast
Value per share
$47.33
Book value per share
$15.41
Value from residual income
67.4%
ROE, latest year
16.96%
required 8.00%
Single-stage value
$46.10
Implied growth
3.25%
EVA
$112.3m
MVA
$2,825.7m
Clean surplus holds
Yes
Residual income by year
| $m | Opening book | Net income | Equity charge | Residual income | Present value |
|---|---|---|---|---|---|
| F1 | 1,497.1 | 261.7 | 119.8 | 141.9 | 131.4 |
| F2 | 1,555.0 | 270.9 | 124.4 | 146.5 | 125.6 |
| F3 | 1,614.7 | 280.1 | 129.2 | 150.9 | 119.8 |
| F4 | 1,676.4 | 289.6 | 134.1 | 155.5 | 114.3 |
| F5 | 1,740.0 | 299.5 | 139.2 | 160.3 | 109.1 |
Clean surplus
| $m | Opening equity | Net income | Paid out | Closing equity | Difference |
|---|---|---|---|---|---|
| Y6 | 1,303.4 | 223.0 | 185.3 | 1,341.1 | 0.0 |
| Y7 | 1,341.1 | 230.6 | 190.6 | 1,381.1 | 0.0 |
| Y8 | 1,381.1 | 227.6 | 196.9 | 1,411.8 | 0.0 |
| Y9 | 1,411.8 | 243.9 | 203.1 | 1,452.6 | 0.0 |
| Y10 | 1,452.6 | 253.9 | 209.4 | 1,497.1 | 0.0 |
Residual income models need every change in equity to pass through net income or payouts. Items that skip the income statement would show as a difference here.