Understanding Residual Income Calculation

Hard Equity Valuation Techniques Residual Income Models

XYZ Corporation has reported a net income of $1 million for the year. It has retained earnings of $5 million and assets totaling $10 million. The company's equity charge (cost of equity) is 10%. To evaluate the intrinsic value of XYZ Corporation using the Residual Income Model, which of the following statements correctly characterizes the calculation of residual income?

Residual income is calculated as net income minus the equity charge on invested capital.

Residual income is equal to net income divided by total assets.

Residual income is computed by adding the equity charge to net income.

Hint

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