Formula
Residual Income = Net Income - (Required Return x Beginning Book Value)
Workflow
1
Start from current book value per share.
2
Estimate income above the required return on book value.
3
Discount residual income and add it to current book value.
Best Used For
- Financials and other companies where book value remains economically meaningful.
- Valuation checks where free cash flow is hard to interpret.
Limitations
- Requires clean book value and sustainable return-on-equity assumptions.
- Can mislead when accounting equity is heavily distorted.