Eyster Corporation reported $10 million in earnings and paid dividends of $3 million for fiscal 2005. Return on equity and dividend payout are expected to remain constant for the foreseeable future. Net book value at the end of fiscal 2004 was 100 million. Cost of equity is 10%. Using the residual income method, the intrinsic value of Eyster's stock at the end of 2005 should be:

Question

Quizplus · Accepted Answer

The intrinsic value of Eyster's stock at the end of 2005 can be calculated using the residual income model. First, calculate the equity book value at the end of 2005, which is the book value at the end of 2004 ($100 million) plus earnings ($10 million) minus dividends ($3 million), resulting in $107 million. The residual income is the earnings minus the equity charge (cost of equity times the beginning book value), which is $10 million - (10% of $100 million) = $10 million - $10 million = $0. Thus, the intrinsic value equals the book value at the end of 2005, which is $107 million. However, the correct calculation of residual income should consider the earnings exceeding the equity charge, and in this case, since the residual income is $0, the intrinsic value is essentially the book value at the end of 2005. Given the choices, the closest correct answer provided is $101 million, but based on the explanation, it seems there might be a misunderstanding in the calculation or the options provided. The correct approach indicates the value should be around the updated book value, but none of the options accurately reflect this based on the given calculation method.

Eyster Corporation Reported $10 Million in Earnings and Paid Dividends