I would like to assess and calculate the Value-to-Book ratio. Based on what it says about this ratio, I must use the formula called Residual income approach to find the Value-to-Book ratio. If you look at the picture I uploaded, there is a word problem associated with the Residual income approach. In the word problem, it mentions that the investors expect to earn a 12% return. Is or does this 12% represent the return on/by/of an equity security, also called shares in common stock? Or, does this 12% that investors expect to earn represent a 12% return on a combined common stock and debt security?

On the picture of the Excel worksheet called discount rate, is this Risk-free long term U.S. Government bond rate of 2.6% is the Investors expected (required) return on/by/of a debt security (e.g., bonds)?

On the picture of the Excel worksheet called discount rate, is this Cost of equity (discount rate) of 13.1% actually the Investors expected (required) return on/by/of a equity security, or a common stock?

What must I do to determine how much money the shareholders, a type of investor, have invested in shares of a company's stock? Or, is this not possible?

Revenue growth has nothing to do with free cash flow, correct? As a result, it would be incorrect of me to say that the free cash flow of the company is expected to grow at 2.5%, a percentage that appears on the top left hand corner of Excel worksheet called prospective analysis.

Suppose investors have invested $10,000 in common equity in a company. Given the risk of the company, the investors expect to earn a 12% return, and they expect the company to pay out 100% of income in dividends each year. The required income of the company each period is as follows: RE X BV-1 = 0.12 x $10,000 = $1,200 Suppose the investors forecast that the company will generate exactly $1,200 in comprehensive income each year. The investors should compute the residual income of the firm as follows: CI, - (REX BV,-1) = $1,200 - (0.12 x $10,000) = $0 Using the residual income approach, investors would value this firm based on book value plus expected future residual income as follows: Vo = BV, + CI, - (REX BV-1) (1 +RE) = $10,000+ $1,200 - (0.12 x $10,000) (1 + 0.12) $O = $10,000+ = $10,000 = (1 +0.12) = Using the same notation from prior chapters, we compute the VB ratio using the following model: (ROCE, - REX BV-1 V = 1+ BV. BV (1 + RE) In short, the VB ratio should be equal to 1 plus the present value of the expected future residual return on common equity (the (ROCE,- Rp) term above) times cumula- tive growth in book value (the BV 2/BV, term above). The growth in book value indi- t=1 B C D E G 1 1 2 Company ABC Inc. 3 Development of Discount Rate and Capitalization Rate 0 h N 4 7 Note (A) Rate 2.6 % 6.0 1.5 3.0 8 Risk-free long term U.S. Government bond rate 9 Equity risk premium 10 Industry premium estimate 11 Specific company risk @ 12 13 13.1 (2.5) Sum of (A) - (D) (E) 14 Cost of equity (Discount rate) 15 Less: Long-term sustainable growth rate 16 17 Capitalization rate 10.6 % 18 19 20 (A) Yield on the twenty-year U.S. Treasury bond as of December 31, 20xx, per the U.S. Treasury 21. (B) Long-horizon expected return of large stocks over risk free securities, U.S. Equity Risk Premium (6.0%) 22 (C) SIC code XX, 1.5% 23 (D) Appraiser's judgement concerning company-specific risk 24 (E) Estimated long-term growth rate based on inflation, Federal Reserve Bank of Philadelphia 25 26 Sources: Listad tatas T. GALLE income statement balance sheet ratios prospective analysis discount rate dcf 2019 2020 2021 2022 Terminal $ 132,400 2.5% $ 135,700 2.5% $ 139,100 $ 142,600 2.5% 2.5% $ 146,200 2.5% 9,268 7.0% 9,499 7.0% 9,737 7.0% 9,982 7.0% 10,234 7.0% 1 Company ABC Inc. 2 Projected Income Statement (In millions) 3 4 5 6 2018 7 8 Revenue $ 129,200 9 Growth 2.5% 10 11 Gross profit 9,044 12 Percentage of revenue 7.0% 13 14 Operating expenses 6,460 15 Percentage of revenue 5.0% 16 17 Other income (expense) 18 Interest income (expense) (4,833) 19 Other 2,364 20 (2.469) 21 Percentage of revenue -1.9% 22 23 Net income $ 115 24 25 26 6,620 5.0% 6,785 5.0% 6,955 5.0% 7,130 5.0% 7,310 5.0% (4.730) (2.900) (7,630) -5.8% (4,247) (539) (4,786) -3.5% (1,101) 320 (781) -0.6% (500) 150 (350) -0.2% (500) 150 (350) -0.2% $ (4,982) $ (2,072) $ 2,001 $ 2,502 $ 2,574 income statement balance sheet ratios prospective analysis discount rate dcf valu Projected for Years Ending December 31 Terminal Value 2019 2020 2021 2022 $ (4,982) S (2,072) S 2,001 $ 2,502 $ 2,574 16,682 16.720 16,744 17,100 17,100 1 2 Company ABC Inc. 3 Discounted Cash Flow Method (In millions) 4 5 6 7 8 9 2018 10 11 Forecasted Net Income $ 115 12 Plus: 13 Depreciation 17,403 14 Less: 15 Capital expenditures 18.121 16 Debt reduction (14,588) 17 18 Net Cash Flow $ 21,051 19 20 Present value of cash flows $ 18,613 21 22 Discount rate: 13.1% 23 24 25 Terminal period cash flows 26 Capitalization rate: 10.6% 27 28 Capitalized terminal cash flow 29 30 Net present value of terminal cash flow, discounted into perpetuity 31 19,311 (23,866) 19,638 (17.188) 19,638 (14,982) 18,001 (12,649) 18,001 (12.649) $ 7,145 $ 17,098 $ 23,401 $ 24,954 $ 25,026 $ 5,586 $ 11,818 $ 14,302 $ 13,484 S 25,026 10.6% S 236,094 $ 127,600 S 32 33 Net present value - five years ending YE: 2022 34 Net present value of terminal cash flow 35 36 Total indication of value (rounded) 63,800 127,600 S 191,400 37 38 39 1 2 4 5 Suppose investors have invested $10,000 in common equity in a company. Given the risk of the company, the investors expect to earn a 12% return, and they expect the company to pay out 100% of income in dividends each year. The required income of the company each period is as follows: RE X BV-1 = 0.12 x $10,000 = $1,200 Suppose the investors forecast that the company will generate exactly $1,200 in comprehensive income each year. The investors should compute the residual income of the firm as follows: CI, - (REX BV,-1) = $1,200 - (0.12 x $10,000) = $0 Using the residual income approach, investors would value this firm based on book value plus expected future residual income as follows: Vo = BV, + CI, - (REX BV-1) (1 +RE) = $10,000+ $1,200 - (0.12 x $10,000) (1 + 0.12) $O = $10,000+ = $10,000 = (1 +0.12) = Using the same notation from prior chapters, we compute the VB ratio using the following model: (ROCE, - REX BV-1 V = 1+ BV. BV (1 + RE) In short, the VB ratio should be equal to 1 plus the present value of the expected future residual return on common equity (the (ROCE,- Rp) term above) times cumula- tive growth in book value (the BV 2/BV, term above). The growth in book value indi- t=1 B C D E G 1 1 2 Company ABC Inc. 3 Development of Discount Rate and Capitalization Rate 0 h N 4 7 Note (A) Rate 2.6 % 6.0 1.5 3.0 8 Risk-free long term U.S. Government bond rate 9 Equity risk premium 10 Industry premium estimate 11 Specific company risk @ 12 13 13.1 (2.5) Sum of (A) - (D) (E) 14 Cost of equity (Discount rate) 15 Less: Long-term sustainable growth rate 16 17 Capitalization rate 10.6 % 18 19 20 (A) Yield on the twenty-year U.S. Treasury bond as of December 31, 20xx, per the U.S. Treasury 21. (B) Long-horizon expected return of large stocks over risk free securities, U.S. Equity Risk Premium (6.0%) 22 (C) SIC code XX, 1.5% 23 (D) Appraiser's judgement concerning company-specific risk 24 (E) Estimated long-term growth rate based on inflation, Federal Reserve Bank of Philadelphia 25 26 Sources: Listad tatas T. GALLE income statement balance sheet ratios prospective analysis discount rate dcf 2019 2020 2021 2022 Terminal $ 132,400 2.5% $ 135,700 2.5% $ 139,100 $ 142,600 2.5% 2.5% $ 146,200 2.5% 9,268 7.0% 9,499 7.0% 9,737 7.0% 9,982 7.0% 10,234 7.0% 1 Company ABC Inc. 2 Projected Income Statement (In millions) 3 4 5 6 2018 7 8 Revenue $ 129,200 9 Growth 2.5% 10 11 Gross profit 9,044 12 Percentage of revenue 7.0% 13 14 Operating expenses 6,460 15 Percentage of revenue 5.0% 16 17 Other income (expense) 18 Interest income (expense) (4,833) 19 Other 2,364 20 (2.469) 21 Percentage of revenue -1.9% 22 23 Net income $ 115 24 25 26 6,620 5.0% 6,785 5.0% 6,955 5.0% 7,130 5.0% 7,310 5.0% (4.730) (2.900) (7,630) -5.8% (4,247) (539) (4,786) -3.5% (1,101) 320 (781) -0.6% (500) 150 (350) -0.2% (500) 150 (350) -0.2% $ (4,982) $ (2,072) $ 2,001 $ 2,502 $ 2,574 income statement balance sheet ratios prospective analysis discount rate dcf valu Projected for Years Ending December 31 Terminal Value 2019 2020 2021 2022 $ (4,982) S (2,072) S 2,001 $ 2,502 $ 2,574 16,682 16.720 16,744 17,100 17,100 1 2 Company ABC Inc. 3 Discounted Cash Flow Method (In millions) 4 5 6 7 8 9 2018 10 11 Forecasted Net Income $ 115 12 Plus: 13 Depreciation 17,403 14 Less: 15 Capital expenditures 18.121 16 Debt reduction (14,588) 17 18 Net Cash Flow $ 21,051 19 20 Present value of cash flows $ 18,613 21 22 Discount rate: 13.1% 23 24 25 Terminal period cash flows 26 Capitalization rate: 10.6% 27 28 Capitalized terminal cash flow 29 30 Net present value of terminal cash flow, discounted into perpetuity 31 19,311 (23,866) 19,638 (17.188) 19,638 (14,982) 18,001 (12,649) 18,001 (12.649) $ 7,145 $ 17,098 $ 23,401 $ 24,954 $ 25,026 $ 5,586 $ 11,818 $ 14,302 $ 13,484 S 25,026 10.6% S 236,094 $ 127,600 S 32 33 Net present value - five years ending YE: 2022 34 Net present value of terminal cash flow 35 36 Total indication of value (rounded) 63,800 127,600 S 191,400 37 38 39 1 2 4 5