
4
Company valuation – an overview 33
This has the important implication that a company must not only break
even but also make a profit large enough to justify the cost of capital it is
using. Residual income can mathematically be expressed as:
RI = (R
E
– C
E
) × BV
t
where RI is the residual income, R
E
is the return on equity, C
E
is the cost of
equity and BV is the book value of the equity at the beginning of the year t.
A residual income model values a company by using a combination of the
company’s book value and a present value of the company’s future resid-
ual income. It can be expressed as:
Enterprise value = BV + (RI/(1 + C
E
)
1
+ RI/(1+C