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Potential dividends versus actual cash flows in firm valuation

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  • Carlo Alberto Magni

    ()

  • Ignacio Velez-Pareja

    ()

Abstract

Practitioners and some academics use potential dividends rather than actual payments toshareholders for valuing a firm´s equity. We underline the differences between the two methods and present some arguments supporting the thesis that firm valuation with potential dividends overstate the actual value of the firm´s equity. In particular, consistently with DeAngelo and DeAngelo (2006, 2007), we underline that cash flows create value for shareholders only if they are withdrawn from the firm, and that the use of potential dividends may lead to contradictions.

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Bibliographic Info

Paper provided by MASTER CONSULTORES in its series PROYECCIONES FINANCIERAS Y VALORACION with number 005516.

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Length: 24
Date of creation: 11 May 2009
Date of revision:
Handle: RePEc:col:000463:005516

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Keywords: Cash flows; cash flow to equity; liquid assets; potential dividends; firm valuation; equity value; miller and modigliani;

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  1. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 323-29, May.
  2. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 34, pages 411.
  3. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, Financial Management Association, vol. 31(2), Summer.
  4. Harry DeAngelo & Linda DeAngelo, 2007. "Payout Policy Pedagogy: What Matters and Why," European Financial Management, European Financial Management Association, European Financial Management Association, vol. 13(1), pages 11-27.
  5. DeAngelo, Harry & DeAngelo, Linda, 2006. "The irrelevance of the MM dividend irrelevance theorem," Journal of Financial Economics, Elsevier, Elsevier, vol. 79(2), pages 293-315, February.
  6. Varian, Hal R, 1987. "The Arbitrage Principle in Financial Economics," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 1(2), pages 55-72, Fall.
  7. Magni, Carlo Alberto, 2007. "Relevance or irrelevance of retention for dividend policy irrelevance," MPRA Paper 5591, University Library of Munich, Germany.
  8. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
  9. James E. Smith & Robert F. Nau, 1995. "Valuing Risky Projects: Option Pricing Theory and Decision Analysis," Management Science, INFORMS, INFORMS, vol. 41(5), pages 795-816, May.
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