Valuation Using the Residual Income Valuation Model

This chapter discusses the derivation and use of the residual income and abnormal earnings growth (AEG) valuation models to value the firm’s equity. The chapter begins with a discussion of the assumptions of the residual income valuation model and how the model is derived from this assumption. We then illustrate how the firm’s residual income is calculated. The chapter then illustrates how the zero-growth and single-stage growth residual income valuation models are used to value equity. We then derive the return on equity (ROE)-based residual income valuation model and illustrate how it is used to value equity. The residual income valuation model can be adapted and used to value the firm.