Explanation

This question relates to the residual income valuation model:

Residual Income Model Formula:

• Value = Book Value + Present Value of Future Residual Earnings

Justified P/B Ratio:

• P/B = 1 + (Present Value of Future Residual Earnings / Book Value)

Given:

• Present Value of Future Residual Earnings = 0

Calculation:

• P/B = 1 + (0 / Book Value) = 1 + 0 = 1

When the present value of expected future residual earnings is zero, it means the company is expected to earn exactly its required rate of return on its book value. Therefore, the company's value equals its book value, and the justified P/B ratio equals 1.

This represents a situation where the company is fairly valued at its book value, neither creating nor destroying economic value.