What is residual income valuation?

Residual income valuation (RIV) assesses a company based on its cost of equity capital. It determines the amount of operating profit remaining once equity capital’s paid. Cost of equity capital is the rate of return required by stockholders, and reflects the risk exposure of their investments.

Where have you heard about residual income valuation?

Also known as “residual income model” (RIM), you’ll be familiar with these terms if you’ve ever invested in common stock or evaluated the financial health of a company.

Residual income valuation is similar to the calculations used to determine market value added (MVA) and economic value added (EVA) amounts.

What you need to know about residual income valuation.

You can calculate residual income using the following equation:

Residual income = net operating income – (cost of operating assets x cost of capital)

Residual income valuation is designed to assess the true profitability of a company. It demonstrates that even a company with high turnover can have a net profit margin that’s less than its cost of equity capital, meaning it’s unlikely to generate high returns.

Find out more about residual income valuation.

Learn more about how equity capital is calculated and how it impacts an investor’s returns.