Three Residual Income Valuation Methods and Discounted Cash Flow Valuation

Abstract:     
I show that the three residual Income models for equity valuation always yield the same value as the Discounted Cash Flow Valuation models.

I use three residual income measures: Economic Profit (EP), Economic Value Added (EVA) and Cash Value Added (CVA). I first show that the present value of the EP discounted at the required return to equity plus the equity book value equals the value of equity (the present value of the Equity cash flow discounted at the required return to equity).

Then, I show that the present value of the EVA discounted at the WACC plus the enterprise book value (equity plus debt) equals is the enterprise market value ( the present value of the Free cash flow discounted at the WACC).

Then, I show that the present value of the CVA discounted at the WACC plus the enterprise book value (equity plus debt) is also equal to the enterprise market value.

Keywords: Cash value added, EVA, Economic profit, Residual income valuation, Discounted cash flow valuation, Valuation

JEL Classifications: G12, G31, M21

Working Paper Series