Why residual income value estimates will not be distorted

Reference no: EM13902341

THE EFFECTS OF AGGRESSIVE ACCOUNTING ON RESIDUAL INCOME VALUATION. Suppose you are applying the residual income valuation model to value a firm with extremely aggressive accounting. Suppose, for example, the firm has a substantially overvalued asset on the balance sheet. (Perhaps the firm has a large amount of goodwill on the balance sheet from a prior acquisition and has delayed record- ing a necessary impairment charge that would write off the value of the goodwill.) As a con- sequence of this extremely aggressive accounting, the firm reports assets and equity at book values that are much higher than their respective economic values. Explain why the residual income value estimates will not be distorted by aggressive accounting. How does the residual income valuation model correct for the effects of aggressive accounting and over- stated book values of equity?

Reference no: EM13902341

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