Rather than forecasting a long stream of dividends or free cash flows, residual income valuation starts from a company’s book value and adds only the profit earned above what shareholders require.
How it works
Cost of equity times book value gives the equity charge — the minimum profit shareholders require. Subtracting that from net income gives residual income, and adding the present value of a perpetually growing residual income stream to book value gives intrinsic value.
What this does not include
This does not include multi-stage residual income forecasts (a common refinement that models several years of changing residual income before assuming a stable perpetual growth rate) — this calculator uses a single-stage perpetuity for simplicity.
How to use this calculator
- Enter book value of equity, net income, cost of equity, and a perpetual growth rate.
Frequently asked questions
Why is residual income valuation less sensitive to terminal value assumptions?
Because it starts from a large, already-known figure (book value) and adds a comparatively small adjustment (the discounted residual income), unlike a pure discounted cash flow model where nearly all the value often comes from an uncertain terminal value.
What does it mean if residual income is negative?
It means the company is earning less than shareholders require on their invested capital — the intrinsic value estimate falls below book value in that case.
Is this the same model as economic value added (EVA)?
They’re closely related concepts — both measure profit in excess of a capital charge — but residual income valuation is specifically an equity-level model using cost of equity and book value, while EVA is typically a firm-level (enterprise) measure using WACC and invested capital.
