There exists a company financed 100% by equity with $1 million of assets.

The company generates a 10% return on assets each year for the first 2 years.

All earnings are reinvested back into the same asset.

At the start of year 3, the company borrows 2,000,000 at 5% interest. The company Is able to generate returns on assets of 7% prior to annual interest payments for years 3 & 4. After year 4, income is expected to grow 5% each year.

Required:

a. Show the earnings for years 1 thru 4.

b. Show the residual earnings for years 1-4 and a terminal residual income assuming the discount rate is 6%.

c. Calculate the value of the company at time 0 using the Residual Income Model.