Advantages and disadvantages of residual method of valuation

Advantages and disadvantages of residual method of valuation - The residual income approach, the value of a company's stock can be calculated as the sum of its book value and the present value of its expected future residual income, discounted at the cost of equity,, resulting in the general formula:{\displaystyle v_{0}=bv_{0}+\sum _{t=1}^{\infty }{ri_{t} \over (1+r)^{t}}}. Can be seen, the residual income valuation formula is similar to the dividend discount model (ddm) (and to other discounted cash flow (dcf) valuation models), substituting future residual earnings for dividend (or free cash) payments (and the cost of equity for the weighted average cost of capital). Certain multiples such as ev/ebitda are also a useful complements to valuations of minority interests, especially when the p/e ratio is difficult to interpret because of significant differences in capital structures, in accounting policies or in cases where net earnings are negative or low. Here, "residual" means in excess of any opportunity costs measured relative to the book value of shareholders' equity; residual income (ri) is then the income generated by a firm after accounting for the true cost of capital.

Residual Valuation

Explanation to the residual method of property valuation.