List and explain the Ohlson’s clean surplus formula and OJ residual income valuation model.

Solutions

Expert Solution

1. Clean surplus accounting is calculated by equating change in book value to earnings - dividends. The theory's primary objective is to estimate the value of company's shares and to determine the cost of capital. Market value is expressed in terms of balancesheet and income statement components. The theory assumes:

The market value of a firm = net book value of the firm’s net assets + present value of future abnormal earnings (goodwill).

Key Points:

1. Actual earnings are based on “clean surplus” - ensures that all gains or losses go through the income statement. 2. Goodwill is calculated as the difference between actual and expected earnings (the same concept as abnormal earnings).

3. Net worth of the firm + calculated goodwill = firm value.

2. OJ residual income balancesheet model:

This model is developed by Ohlson and Juettner. This models says that growth in earnings is due to price to forward earnings ratio. It takes in to account the short term growth and long term growth to derive the explanation of price to forward earnings. This model is not based on expectation of dividend and can be viewed as a more profiund explanation of the constant growth model. The essence of this model is in seeking answer to the question that how growth in earnings can be achieved without carrying the dividend burden.

jeff jeffy answered 1 year ago

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