Equivalence between Discounted Cash Flow (DCF) and Residual Income (Ri) (Su Tuong Duong Giua Dong Tien Chiet Khau Va Thu Nhap Rong)

Financial Project Appraisals Working Paper No. 001-2003

20 Pages Posted: 5 May 2003

See all articles by Joseph Tham

Joseph Tham

Educational Independent Consultant

Tran Viet Thang

SAIGON COMMERCIAL BANK (SCB); affiliation not provided to SSRN

Date Written: February 2003

Abstract

Recently, the residual income (RI) model has become very popular in valuation because it purports to measure "value added" by explicitly taking into account the cost for capital in the income statement. Some proponents of the residual income approach have even suggested that the RI model is superior to the discount cash flow (DCF) method and consequently, the DCF model should be abandoned in favor of the RI model. The residual income model is seductive because it purports to provide assessments of performance at any given point in time. The claim that the RI model is superior to the DCF model in valuation is puzzling because the RI model is simply an interesting algebraic rearrangement of the DCF model. Since the same information is used in both models, it is not unexpected that both models should give the same valuation results.

In this paper, I examine the idea that the residual income model is superior to the discounted cash flow model. Using a simple numerical example, I show that in a M & M world, the two approaches to valuation are equivalent. In practice, the choice between the two valuation methods will be determined by the ease with which the relevant information is available.

Note: The downloadable paper is in Vietnamese.

Keywords: Economic Value Added, Residual Income Model, Cash Flow Model

JEL Classification: D61, G31, H43

Suggested Citation

Tham, Joseph and Thang, Tran Viet and Thang, Tran Viet, Equivalence between Discounted Cash Flow (DCF) and Residual Income (Ri) (Su Tuong Duong Giua Dong Tien Chiet Khau Va Thu Nhap Rong) (February 2003). Financial Project Appraisals Working Paper No. 001-2003, Available at SSRN: https://ssrn.com/abstract=381880 or http://dx.doi.org/10.2139/ssrn.381880

Joseph Tham

Educational Independent Consultant ( email )

Tran Viet Thang (Contact Author)

SAIGON COMMERCIAL BANK (SCB) ( email )

4- HO XUAN HUONG
Hanoi, 10000
Vietnam
084-04-9438732 (Phone)
084-04-9438734 (Fax)

affiliation not provided to SSRN

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
1,240
Abstract Views
10,991
rank
21,113
PlumX Metrics