Question #37 - Reading 23 Residual Income Valuation

Reading: Reading 23 Residual Income Valuation

PDF File: Reading 23 Residual Income Valuation.pdf

Page: 21

Status: Unattempted

Shared Context

- Which of the following is least likely to characterize the difference between a residual income model and a FCFE model? A) Terminal value represents a higher proportion of intrinsic value in a residual income model than in a dividend discount model (DDM). B) A residual income model is applicable to a firm that does not have FCF. C) Inputs to a residual income model are more easily manipulated by management.

Question

The residual income of Geremiah Analytics is closest to:

Answer Choices:

A. −$120,000

B. $120,000

C. $1,080,000.00

Explanation

Geremiah's after-tax income is ($3 × (1 − 0.40)) = $1.8 million. They have ($40 × 0.60) = $24 million in debt and ($40 × (1 − 0.60)) = $16 million in equity. Their equity charge is ($16 × 0.12) = $1.92 million. Their residual income is ($1.8 − $1.92) = −$0.12 million, or −$120,000.

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