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 net income:
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Year +1:
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$213,948
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Year +2:
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$192,008
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Year +3:
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$187,444
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Year +4:
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$196,442
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Year +5:
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$206,667
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The accountant expects net income to grow 5 percent annually after Year +5. Kelsey with- draws 30 percent of net 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 percent 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?