Glossary
Residual income model
M3.04 · M5.01Also called residual income valuation, abnormal earnings model.
Valuing equity as its book value plus the present value of all future earnings above the charge for equity capital.
A company with ₹3,300 crore of book value earning ₹615 crore against a 13% cost of equity generates ₹186 crore of residual income, and capitalising that in perpetuity gives a value of ₹4,731 crore.
The appeal is that most of the answer sits in the book value, which is observed, rather than in a terminal value, which is assumed. That makes it well suited to banks and to any business where the balance sheet carries assets at something near economic value.
It also makes the value-creation logic explicit: a company earning exactly its cost of equity is worth its book value and no more.
Book value is the anchor. Everything above it has to be earned.