Explanation

When a company's ROE is expected to fade toward its cost of equity, this means that the company's competitive advantage is diminishing and it will eventually earn only its required return. In the residual income model:

• Residual Income (RI) = (ROE - r) × Book Value
• As ROE approaches the cost of equity (r), the residual income approaches zero
• When residual income is zero, the company is earning exactly its required return

Therefore, the continuing residual income (the residual income in the terminal period) should approach zero. This is consistent with the economic reality that competitive forces will eliminate abnormal returns over time.

Option A is incorrect because a persistence factor of one would imply that residual income persists indefinitely, which contradicts the fading ROE assumption.

Option C is incorrect because when residual income fades to zero, the terminal value becomes smaller, not larger.