$$\begin{array}{l}
\text { Rivaz Corporation }\
\begin{array} { l r }
& 2005 \
\text { Net Income } & \$ 3,000 \
\text { Dividends } & \$ 1,000 \
\text { Total Assets } - 12 / 31 / 05 & \$ 35,000 \
\text { Total Liabilities } - 12 / 31 / 05 & \$ 21,225 \
\text { Number of shares outstanding } & 1,000 \
\text { Cost of Equity } & 12 \%
\end{array}
\end{array}$$
-Net income is expected to increase by 10% for the next year, and dividend payout ratio is expected to remain constant. After 2006, retained earnings are expected to decrease to zero. Using the residual income method what is the value per share of Rivaz stock as of 12/31/05?
A)$15.25
B)$15.16
C)$14.38
D)$13.77

Question

$$\begin{array}{l}
\text { Rivaz Corporation }\
\begin{array} { l r } 
& 2005 \
\text { Net Income } & \$ 3,000 \
\text { Dividends } & \$ 1,000 \
\text { Total Assets } - 12 / 31 / 05 & \$ 35,000 \
\text { Total Liabilities } - 12 / 31 / 05 & \$ 21,225 \
\text { Number of shares outstanding } & 1,000 \
\text { Cost of Equity } & 12 \%
\end{array}
\end{array}$$
-Net income is expected to increase by 10% for the next year, and dividend payout ratio is expected to remain constant. After 2006, retained earnings are expected to decrease to zero. Using the residual income method what is the value per share of Rivaz stock as of 12/31/05?
A)$15.25
B)$15.16
C)$14.38
D)$13.77

Quizplus · Accepted Answer

The correct answer is A.The residual income method values a company based on the present value of its future residual income. Residual income is calculated as net income minus the cost of equity multiplied by the book value of equity. In this case, the net income is expected to increase by 10% for the next year, and the dividend payout ratio is expected to remain constant. After 2006, retained earnings are expected to decrease to zero. Therefore, the residual income for the next year will be $3,000 * (1 + 0.1) - $1,000 * 12% * $35,000 = $2,400. The present value of the residual income for the next year is $2,400 / (1 + 0.12) = $2,143. The value per share of Rivaz stock as of 12/31/05 is $2,143 / 1,000 = $2.14.

-Net Income Is Expected to Increase by 10% for the 2005