Wednesday, 7 March 2012

Residual Income - An important point to ponder

The formula is pretty straight forward:

RI(t) = E(t) - rB(t-1)

RI(t) = Residual Income at t
E(t) = Earnings at t
r = required rate of return on equity
B(t-1) = Ending Book value at t-1 or Beginning book value at t

The Earning is expected for the next year but the book value is current. This is an important point but I don't know why I was skipping it continuously. While calculating the residual income for several years I was also projecting the book value but I repeated this mistake multiple times that the book value I took to calculate RI was ending not the beginning at time t which made several of my questions wrong. In few questions an option was also there which reflected the number calculated using ending book value at time t. It implies that the question designer had this thing in mind that the candidates can make this mistake. This is an important point which I learned, thought to share it with you guys. 

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