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
AbstractPractitioners and academics in valuation include changes in liquid assets (potential dividends) in the cash flows. This widespread and wrong practice is inconsistent with basic finance theory. We present economic, theoretical, and empirical arguments to support the thesis. Economic arguments underline that only flows of cash should be considered for valuation; theoretical arguments show how potential dividends lead to contradiction and to arbitrage losses. Empirical arguments, from recent studies, suggest that investors discount potential dividends with high discount rates, which means that changes in liquid assets are not value drivers. Hence, when valuing cash flows, we should consider only actual payments.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 7266.
Date of creation: 19 Feb 2008
Date of revision:
Cash flows; cash flow to equity; free cash flow; liquid assets; potential dividends; firm value; equity value; Modigliani and Miller; levered value; error in valuation;
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- M40 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - General
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