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Problem - Equity Valuation Using the Residual Income Model - Morrissey Tool Company manufactures machine tools for other manufacturing firms. The firm is wholly owned by Kelsey Morrissey. The firm's accountant developed the following long-term forecasts of comprehensive income:
Year +1: $213,948
Year +2: $192,008
Year +3: $187,444
Year +4: $196,442
Year +5: $206,667
The accountant expects comprehensive income to grow 5% annually after Year +5. Kelsey withdraws 30% of comprehensive income each year as a dividend. Total common shareholders' equity on January 1, Year +1, is $1,111,141. Kelsey expects to earn a rate of return on her invested equity capital of 12% each year.
REQUIRED -
a. Using the residual income valuation model, compute the value of Morrissey Tool Company as of January 1, Year +1.
b. What advice would you give Kelsey regarding her ownership of the firm?
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