Where exactly does the equity charge enter a residual income valuation?

The equity charge is the middle step. It converts accounting earnings into economic profit.

The sequence is:

1. Start with beginning book value.
2. Multiply beginning book value by the required return on equity.
3. Subtract that equity charge from forecast net income.
4. Discount the residual-income stream.
5. Add the discounted residual income to current book value.

Example using fictional company Summerset Rail Parts:

• beginning book value per share = 32
• forecast EPS = 4.9
• required return = 12%

Equity charge = 32 x 0.12 = 3.84

Residual income = 4.9 - 3.84 = 1.06

That 1.06 is what gets discounted as value creation above the shareholders' required return.

If you skip the equity charge, you are valuing accounting profit rather than excess economic profit.