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Potential dividends versus actual cash flows in firm valuation

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Author Info
Magni, Carlo Alberto
Vélez-Pareja, Ignacio

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Abstract

Practitioners and some academics use potential dividends rather than actual payments to shareholders 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with DeAngelo and DeAngelo (2006, 2007), we underline that cash flows create value for shareholders only if they are withdrawn from the firm, and that the use of potential dividends may lead to contradictions. This paper is a modified version of the theoretical part (sections 1-3) of Velez-Pareja, I., and Magni, C.A. (2008). Potential Dividends and Actual Cash Flows. Theoretical and Empirical Reasons for Using ‘Actual’ and Dismissing ‘Potential’, Or: How not to Pull Potential Rabbits Out of Actual Hats.

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File URL: http://mpra.ub.uni-muenchen.de/14685/
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Publisher Info
Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 14509.

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Date of creation: 09 Mar 2009
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Handle: RePEc:pra:mprapa:14509

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Related research
Keywords: Cash flows; cash flow to equity; liquid assets; potential dividends; firm valuation; equity value; Modigliani and Miller;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
M41 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - Accounting
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
M40 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - General
G30 - Financial Economics - - Corporate Finance and Governance - - - General
M21 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics - - - Business Economics

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  1. Harry DeAngelo & Linda DeAngelo, 2007. "Payout Policy Pedagogy: What Matters and Why," European Financial Management, Blackwell Publishing Ltd, vol. 13(1), pages 11-27. [Downloadable!] (restricted)
  2. DeAngelo, Harry & DeAngelo, Linda, 2006. "The irrelevance of the MM dividend irrelevance theorem," Journal of Financial Economics, Elsevier, vol. 79(2), pages 293-315, February. [Downloadable!] (restricted)
  3. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
  4. Varian, Hal R, 1987. "The Arbitrage Principle in Financial Economics," Journal of Economic Perspectives, American Economic Association, vol. 1(2), pages 55-72, Fall. [Downloadable!] (restricted)
  5. Magni, Carlo Alberto, 2007. "Relevance or irrelevance of retention for dividend policy irrelevance," MPRA Paper 5591, University Library of Munich, Germany, revised 2009. [Downloadable!]
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This page was last updated on 2009-11-23.

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