Residual Income Treatment of Interim Dividends

CFA Level II Equities
#1

Hi all

I’m going through the materials on Residual Income using the Kaplan Schweser notes (Book 3, Study Session 11).

There is a question in Module Quiz 32.4 (Q3, p208) that asks for the value per share of a stock using the residual income model. I understand the residual income calculations but in the answer, the value per share takes no account of dividends paid over the foreseeable future (the question explicitly states that dividend payout ratio is 40%). My answer included treating those interim dividends as cash flows, discounted at the required return on equity, in addition to the value derived from the residual income over the period.

Is this an error in the book or does the residual income valuation approach essentially ignore interim cash flows? The latter seems strange but perhaps I am not understanding how that same value is being captured as part of the residual income approach.

Thank you in advance.

#2

I am not using schweser. But generally, Residual Income = Net Income- Equity Charge. If you use residual income model, it’s always Book valuer per share+ discounted Residual income. ( only DDM will factor in dividend)

Equity charge= return on equityX book value at the beginning of the period. ( Return on equity already factors in capital appreciation and dividend)

#3

Welcome to L2. Questions will provide excess data to lead you to make mistakes and get confused.

marktekfx got it right.