It is thus possible that a value deemed positive using a traditional discounted cash flow (DCF) approach may be negative here.
The currency charge to be subtracted is then simply and Using the residual income approach, the value of a company's stock can be calculated as the sum of its book value today (i.e. at time
, resulting in the general formula: Here various adjustments to the balance sheet book value may be required;[1] see Clean surplus accounting.
In the first step, analysts commonly employ the Perpetuity Growth Model to calculate the terminal value — although various, more formal approaches are also applied [3] — which returns: In the second step, the RI valuation is then: As can be seen, the residual income valuation formula is similar to the dividend discount model (DDM) (and to other discounted cash flow (DCF) valuation models), substituting future residual earnings for dividend (or free cash) payments (and the cost of equity for the weighted average cost of capital).
[4] At the same time, in addition to the accounting considerations mentioned above, the RI approach will not generally hold if there are expected changes in shares outstanding or if the firm plans to bring in "new" shareholders who derive a net benefit from their capital contributions.