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The Re-emergence of the Residual Income Model in the Valuation of Firms and Investment Projects

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  • Cziglerné Erb, Edina

Abstract

Residual income valuation was already known and used in valuation theory and practice previously, however, the method has been subject to increasing attention in the past decades. By comparing the discounted cash flow method and the residual income model, this paper seeks to answer the question of what practical implications the difference in theory results in. The discounted cash flow method continues to be widely popular in literature and international practice, however, it may give rise to flawed results in certain cases. With the help of specific business examples, the study highlights that in such cases, the risks of under or overestimation can be mitigated with the help of the RIM model. The largest benefit of the residual income model compared to the DCF method is that instead of deriving the value solely from the future, it gives a central role to the already known book value, and the speculative value – determined based on the accounting income – plays a less significant role in the course of valuation.

Suggested Citation

  • Cziglerné Erb, Edina, 2020. "The Re-emergence of the Residual Income Model in the Valuation of Firms and Investment Projects," Public Finance Quarterly, Corvinus University of Budapest, vol. 65(3), pages 430-442.
    • Handle: RePEc:pfq:journl:v:65:y:2020:i:3:p:430-442
    DOI: https://doi.org/10.35551/PFQ_2020_3_7
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    References listed on IDEAS

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    1. Stephen H. Penman & Theodore Sougiannis, 1998. "A Comparison of Dividend, Cash Flow, and Earnings Approaches to Equity Valuation," Contemporary Accounting Research, John Wiley & Sons, vol. 15(3), pages 343-383, September.
    2. Ali Atilla Perek & Seda Perek, 2012. "Residual Income Versus Discounted Cash Flow Valuation Models: An Empirical Study," Accounting & Taxation, The Institute for Business and Finance Research, vol. 4(2), pages 57-64.
    3. Tamás Szücs & József Ulbert, 2017. "Role and Measurement of Fair Valuation in the Hungarian Credit Institution Sector," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 16(3), pages 51-73.
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    More about this item

    Keywords

    residual income; discounted cash flow valuation methods; intrinsic value;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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