Jennergren, L. Peter () (Department of Accounting and Business Law) Skogsvik, Kenth () (Department of Accounting and Business Law)
Abstract
We investigate a disaggregated version of the abnormal earnings growth (AEG) model of Ohlson and Juettner-Nauroth (2005). The value of the firm then becomes discounted free cash flows minus initial debt. Discounted free cash flows are equal to capitalized operating earnings from the initial stock of operating assets plus the present value of an infinite sequence of growth projects, where each growth project is valued by discounted economic value added. Sufficient conditions for the present value of the free cash flows to be equal to the sum of these two components are investigated. The Gordon growth formula is found to be one special case. Another case concerns lumpy growth projects with depreciation according to the annuity method. We then allow for three different interest rates, the required rate of return on equity under all-equity financing, the borrowing rate, and the required rate of return on equity under partial debt financing (the latter given by MM's Proposition 2). In the model of Ohlson and Juettner-Nauroth, these rates are the same. A firm-level model is developed that focuses on operating earnings and free cash flows with discounting at the required rate of return under all-equity financing. An equity-level model is then developed that focuses on bottom-line earnings and dividends with discounting at the required rate of return under partial debt financing. Relationships between the two models are explored. Dividend policy irrelevance holds only in a limited sense for the equity-level model.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Length: 28 pages Date of creation: 28 Sep 2007 Date of revision: Handle: RePEc:hhb:hastba:2007_011
Contact details of provider: Postal: The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, SE 113 83 Stockholm, Sweden Phone: +46-(0)8-736 90 00 Fax: +46-(0)8-31 01 57 Email: Web page: http://www.hhs.se/ More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: (Helena Lundin).