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Equivalent valuations in cash flow and accounting models

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  • Richard Sweeney

Abstract

This paper investigates the equivalence of equity valuation between the free cash flow model and the residual income model. Two conditions are found to be jointly sufficient for Residual Income and Free Cash Flow models to produce the same equity valuation: (a) the models’ discount rates jointly satisfy the Modigliani and Miller (Am Econ Rev 48:261–297, 1958) condition which relates discount rates for levered equity, unlevered equity, tax savings and debt, and (b) forecasts of the two models’ variables jointly satisfy the income statement and balance sheet identities. Past discussions fail by ignoring or misusing (a). Copyright Springer Science+Business Media New York 2014

Suggested Citation

  • Richard Sweeney, 2014. "Equivalent valuations in cash flow and accounting models," Review of Quantitative Finance and Accounting, Springer, vol. 42(1), pages 29-49, January.
    • Handle: RePEc:kap:rqfnac:v:42:y:2014:i:1:p:29-49
    DOI: 10.1007/s11156-012-0332-x
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    2. I-Cheng Yeh & Yi-Cheng Liu, 2023. "Exploring the growth value equity valuation model with data visualization," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-37, December.

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    More about this item

    Keywords

    Cash-flow valuation models; Residual income models; Dividend discount rates; Accounting identities; G11; C52; M41;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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