An Application of Discounted Residual Income for Capital Assets Pricing by Method Curve Fitting with Sinusoidal Functions

Subject Areas : General Management

G. Talebnia ¹ , M. Ebrahimi ² , A. Darvishi ³

1 - Department of Accounting, School of Management and Economics, Science and Research Branch, Islamic Azad University (IAU), Tehran, Iran
2 - Department of Accounting, School of Management and Economics, Science and Research Branch, Islamic Azad University (IAU), Tehran, Iran
3 - Department of Accounting, Isfahan University, Isfahan, Iran

Received: 2014-12-21 Accepted : 2014-12-21 Published : 2015-01-01

Keywords: residual income, Valuation model, Sinusoidal functions, Stock Price, Discounted models,

Abstract :

The basic model for valuation of firm is the Dividend Discount Model (DDM). When investors buy stocks, theyexpect to receive two types of cash flow: dividend in the period during which the stock is owned, and theexpected sales price at the end of the period. In the extreme example, the investor keeps the stock until thecompany is liquidated; in such a case, the liquidating dividend becomes the sales price. The residual incomevaluation model is an alternative model to the divided discounted model or valuation based on multiples indetermining a value of a company. It decomposes the company value of a company into two imaginative parts:(1) the real assets of the company. It is assumed that these assets are leased to the company at a certain rate ofreturn. (2) The present value of the future “Residual Incomes”. Residual income refers to the income part whichis achieved above the expected return on the real assets (the previously mentioned first part). Thus we examinedthe effects of Discounted Residual Income (DRI) on stock price of companies listed in Tehran Security Exchange(TSE) by method curve fitting with sinusoidal functions. Our sample includes 1920 firm- year of companieslisted in TSE during the period 2005-2010.The results show that there is a significant relationship betweendiscounted residual income and firm’s value. Also the result shows that if we use method curve fitting withsinusoidal functions for fitting model, we can regress the best model and the explanatory power of model willincrease.