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A Tutorial on Residual Income Valuation and Value Added Valuation

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  • Skogsvik, Kenth

    (Dept. of Business Administration, Stockholm School of Economics)

Abstract

Two valuation models based on accounting concepts and measurements are specified and discussed in the paper - a "residual income valuation" model and a "value added valuation" model. Given clean surplus accounting, the first model is identical to a model where future expected dividends and a horizon value of owners' equity are discounted to a present value. Similarly, the second model is identical to a free cash flow valuation framework, as specified in the well-known "McKinsey model" (Copeland, Koller & Murrin, 1994). The valuation models being specified in the paper use accounting measures of capital, capital growth and return on capital to calculate a fundamental value of owners' equity. As a certain connection between the required market rate of return ("cost of capital"), the accounting return on capital and capital growth can be expected to hold in the long run, the valuation models provide for some simplification of typical prediction problems inherent in fundamental valuation analysis.

Suggested Citation

  • Skogsvik, Kenth, 1999. "A Tutorial on Residual Income Valuation and Value Added Valuation," SSE/EFI Working Paper Series in Business Administration 1999:10, Stockholm School of Economics, revised 03 Sep 2002.
    • Handle: RePEc:hhb:hastba:1999_010
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    Cited by:

    1. Skogsvik, Kenth, 2006. "Probabilistic Business Failure Prediction in Discounted Cash Flow Bond and Equity Valuation," SSE/EFI Working Paper Series in Business Administration 2006:5, Stockholm School of Economics.
    2. Jennergren, L. Peter, 1998. "A Tutorial on the Discounted Cash Flow Model for Valuation of Companies," SSE/EFI Working Paper Series in Business Administration 1, Stockholm School of Economics, revised 13 Dec 2011.

    More about this item

    Keywords

    Conservative accounting; economic value added; financial ratios; fundamental analysis; residual income; valuation;
    All these keywords.

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