Annabel Temitope is evaluating the expected residual income as of the end of September 20X4 for Asia Pulp and Paper Company (PAP), a vertically-integrated pulp and paper producer. Using an adjusted beta of 1.20 relative to the S&P 500 Index, a 10-year government bond yield of 1.70%, and an estimated equity risk premium of 3.80%, Temitope uses the capital asset pricing model (CAPM) to estimate PAPs required rate of return. Temitope obtains the following as of the close of September 20X4.

Exhibit 1. Asia Pulp and Paper Company

Current market price	$11.90
Book value per share as of 31 December 20X3	$9.96
Consensus annual earnings estimates
FY 20X4	$3.52
FY 20X5	$3.64
Annualized dividend per share forecast
FY 20X4	$1.46
FY 20X5	$1.55

David Emmanuel, Temitopes supervisor, has reviewed her computations on the expected residual value income for PAP. He has calculated the stock value of PAP and would like Temitope to do the same. They use different approaches but perform the calculations using consistent assumptions.

• Emmanuels approach: calculate the stock value using the residual income model.
• Temitopes approach: calculate the stock value using the dividend discount model instead.

Cynthia Promise, a co-worker of Temitope, specializes in the airline industry. Recently she has been monitoring Southwest Airlines (NYSE: LUV). She considers a stock to be fairly valued if her intrinsic value calculation using the single-stage residual income model is within 10% of the current market price. She has gathered the following information for LUV:

• Current book value per share = $26
• Current market price per share = $44
• Assumed long-term ROE is 11% and long-term growth is 5.5%
• The cost of equity based on the Capital Asset Pricing Model is 8.5%

Emmanuel asks Temitope and Promise to create a list of strengths and weaknesses of residual income models. They worked together and submitted the following list to Emmanuel. Strength 1: The models focus on economic profitability. Strength 2: The cost of debt capital is reflected appropriately by interest expense. Weakness 1: The models do not work well when cash flows are unpredictable. Weakness 2: Accounting data used as inputs may require significant adjustments.

Emmanuel reviews the list created by Temitope and Promise and makes the following two statements:

Statement 1: The residual income model is most appropriate when a companys dividends are not predictable. Statement 2: The residual income model is least appropriate if the book value is not predictable.

Question 2

Based on the information provided in Exhibit 1, what is the forecast ending book value per share for FY 20X4?

Question 1

Based on the information in exhibit 1, what is the forecast residual income for fiscal year 20X5 that Temitope would calculate?