Abstract

Valuation errors are common and can be extraordinarily costly. The rediscovery of the residual income valuation model creates an opportunity to diminish the frequency of valuation errors by comparing the results of two valuation techniques that must produce identical results: one based on cash flows, the other on residual income. Another necessary condition for reliable valuations is that the value of assets must be equal to the combined value of the firm's outstanding debt and equity securities. Based on these two necessary conditions for reliability, we propose a modeling framework to limit the vulnerability of valuation analysts to challenges resulting from blatant errors of input or from a lack of internal consistency in valuation models.