Key Characteristic of the Residual Income Model

In the context of equity valuation, the Residual Income Model (RIM) is an important tool used by analysts to determine the intrinsic value of a company's equity. This model is particularly useful for valuing companies that do not pay dividends or have unpredictable dividend patterns.

The Residual Income Model calculates the value of equity based on the net income that remains after deducting the equity charge, which is determined by multiplying the company's equity capital by its required rate of return. If a company's actual performance exceeds the expected performance based on the cost of equity, it creates residual income.

Which of the following correctly describes a key characteristic of the Residual Income Model?