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

The basic model for valuation of firm is the Dividend Discount Model (DDM). When investors buy stocks, they expect to receive two types of cash flow: dividend in the period during which the stock is owned, and the expected sales price at the end of the period. In the extreme example, the investor keeps the stock until the company is liquidated; in such a case, the liquidating dividend becomes the sales price. The residual income valuation model is an alternative model to the divided discounted model or valuation based on multiples in determining 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 of return. (2) The present value of the future “Residual Incomes”. Residual income refers to the income part which is achieved above the expected return on the real assets (the previously mentioned first part). Thus we examined the 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 companies listed in TSE during the period 2005-2010.The results show that there is a significant relationship between discounted residual income and firm’s value. Also the result shows that if we use method curve fitting with sinusoidal functions for fitting model, we can regress the best model and the explanatory power of model will increase.