An analyst has been tasked to value ABC Company (ABC) common stock. The analyst gathers the following information on ABC for the most recent year:

• Book value per share, beginning of year: $6.72 per share
• Book value per share, end of year: $7.90 per share
• Earnings per share: $2.02

The analyst forecasts the following annual earnings per share (EPS) and dividends per share (DPS) for ABC over the next three years:

The analyst next estimates residual income per share for the most recent year as well as for the next three years.

The analyst decides to value ABC using the residual income model assuming that ABC will terminate operations at the end of year 3. Consequently, ABC will pay a liquidating dividend at the end of year 3 equal to the book value per share at the beginning of year 3 plus year 3 EPS.

To estimate the required return for ABC, the analyst uses the build-up approach. The Analyst chooses to use a market (equity) risk premium of 4.5%. In addition, the analyst believes a size premium of 4.5% and a company-specific risk premium of 3% are also warranted to compensate for ABC being a small, private firm. The risk-free rate is 1%.

	Year 1	Year 2	Year 3
Expected earnings per share	$3.13	$3.39	$3.75
Expected dividends per share	$0.88	$1.04	?????

What was residual income per share for ABC for the most recent year?

What is forecasted residual income per share for ABC in year 3 based on the analysts

forecast?

(Hint: Begin by creating a table showing the calculation of residual income per share for ABC over the next three years based upon the analysts forecast.)

What is the estimated intrinsic value per share of ABC using the residual income model?

(Hint: You should be able to confirm your answer by calculating the intrinsic value per share of ABC using the dividend income model.)