Jones Corp. Use this information to answer the following questions:
At the end of 2005 Jones Corp. developed the following forecasts of net income:
Management believes that after 2010 Jones will grow at a rate of 7% each year. Total common shareholders' was $112,768 on December 31, 2005. Jones has not established a dividend and does not plan on paying dividends during 2006 to 2010, its cost of equity capital is 12%.
Compute the value of Jones Corp. on January 1, 2006, using the residual income valuation model. Use the half-year adjustment.

Question

Jones Corp. Use this information to answer the following questions:
At the end of 2005 Jones Corp. developed the following forecasts of net income:
 Management believes that after 2010 Jones will grow at a rate of 7% each year. Total common shareholders' was $112,768 on December 31, 2005. Jones has not established a dividend and does not plan on paying dividends during 2006 to 2010, its cost of equity capital is 12%.
Compute the value of Jones Corp. on January 1, 2006, using the residual income valuation model. Use the half-year adjustment.

Quizplus · Accepted Answer

Residual income valuation model = Book value of equity + (ROE - Required return) x Beginning book value of equity

ROE = Net income at 2005 / Book value of equity at 2005 = ($5,304 + $6,280 + $7,453 + $8,717 + $10,088) / $112,768 = 0.106

Required return = Cost of equity capital = 12%

Beginning book value of equity = $112,768 / 1.06 = $106,163.83 (half-year adjustment)

ROE - Required return = 0.106 - 0.12 = -0.014

Residual income = (-0.014) x $106,163.83 = -$1,485.29

Value of Jones Corp. on January 1, 2006 = Book value of equity + Residual income = $112,768 + (-$1,485.29) = $185,328.71 ≈ $185,329. Therefore, the best choice is B.