Question #49
Reading: Reading 23 Residual Income Valuation
PDF File: Reading 23 Residual Income Valuation.pdf
Page: 25
Status: Unattempted
Question
Which description of the relationship among residual income, dividend discount (DDM) and free cash flow to equity (FCFE) models is least accurate?
Answer Choices:
A. Residual income differs from DDM and FCFE in that residual income starts with book value
B. Residual income differs from DDM and FCFE in that it discounts income rather than cash
C. The different models should result in different intrinsic values because of the theoretical differences in the models
Explanation
The three models should all produce the same intrinsic value as long as the underlying
assumptions are the same. The differences in intrinsic values arise from difficulty in
estimating the inputs, not from theoretical differences in the models. Since they should
produce the same results, they can be used to assess consistency. Residual income differs
from DDM and FCFE in the use of accounting assumptions, including book value and
discounting income.