Conflicting formula for justified P/B expected, required, justify

Andreas42

1. Justified P/B = (ROE-r)/(r-g)

2. By using the residual income model, V(0) = B(0) + {(ROE - r) * B(0)}/ ( r-g)
==> V/B = 1 + (ROE - r)/ (r-g)

Related Question:

Century Scales has a required return on equity of 12% and is expected to grow indefinitely at a rate of 5%. The ROE that would justify a P/B of 2.14 is closest to?

ryanlb

V (0) = B(0) + ..... + (RI(n)+ [RI(n+1)/(r-g)])/(1+r)^(n)

The r-g in the denominator is only the last part of the "to infinity and beyond" part of the numerator.

For just the simplest 1-stage RI, the formula would be:

V(0) = RI(1)/(r-g)



Edited 2 time(s). Last edit at Thursday, May 27, 2010 at 05:14PM by gjertsen.

smuggycfa

Your formula for the RI model is incorrect, I'm pretty sure.



Edited 1 time(s). Last edit at Thursday, May 27, 2010 at 05:05PM by gjertsen.

eoin

Justified P/B is (ROE-g)/(r-g). Stalla uses a subscript of 1 for ROE, not sure if we're supposed to grow it or not. Can anyone confirm?

NO EXCUSES

genuinecfa

Justified P/B is (ROE-r)/(r-g), not (ROE-g)/(r-g).

There isn't a dividend or cash flow to grow. What did you want to grow, ROE?
No need to grow anything.

Sportsman

no, P/B = (ROE-g)/(r-g)

kickthatcfa

you can solve this from the RI model:

P = B + [(ROE-r)B] / (r-g)

or

P/B = 1 + (ROE-r) / (r-g)

P/B = (ROE-r) / (r-g) + (r-g) / (r-g)

P/B = (ROE-r + r-g) / (r-g)

P/B = (ROE-g) / (r-g)

thecfawannabe

oh, yes, thanks FinNinja... the first post got me mixed up. Thanks for the correct formula and the algebra.