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Residual Income Valuation (RIV)

Residual Income Valuation (RIV) is a method used to estimate the value of a company based on its residual income. Residual income refers to the income generated after accounting for the cost of capital, which is the required return for shareholders or debt holders. Unlike traditional valuation methods that rely solely on cash flows, the RIV method focuses on the excess income that a company generates over and above its required returns. It is useful for valuing firms that may not have strong cash flows but generate significant returns on equity.

Example

An investor uses the residual income valuation method to value a technology startup that is currently reinvesting heavily in growth but is generating strong residual income above its cost of capital.

Key points

• A valuation method based on income after covering the cost of capital.

• Useful for valuing firms with irregular cash flows but high equity returns.

• Focuses on excess income that exceeds the required return for investors.

Quick Answers to Curious Questions

It captures the profitability of a company after accounting for the required returns for investors, providing a more nuanced valuation.

RIV focuses on the profitability above the cost of capital, while traditional methods rely on projected cash flows and earnings.

It is particularly useful for firms with significant investments in growth or companies that may not have strong cash flows but generate high returns on equity.