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A Synthesis of Equity Valuation Techniques and the Terminal Value Calculation for the Dividend Discount Model

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  • Stephen H. Penman

    (University of California)

Abstract

This paper lays out alternative equity valuation models that involve forecasting for finite periods and shows how they are related to each other. It contrasts dividend discounting models, discounted cash flow models, and “residual income” models based on accrual accounting. It shows that some models that are apparently different yield the same valuation. It gives the general form of the terminal value calculation in these models and shows how this calculation serves to correct errors in the model. It also shows that all models can be interpreted as providing a particular specification of the terminal value for the dividend discount model. In so doing it shows how one calculates the terminal value for the dividend discount formula. The calculation involves weighting forecasted stocks and flows of value with weights determined by a parameter that can be discovered from pro forma analysis.

Suggested Citation

  • Stephen H. Penman, 1998. "A Synthesis of Equity Valuation Techniques and the Terminal Value Calculation for the Dividend Discount Model," Review of Accounting Studies, Springer, vol. 2(4), pages 303-323, December.
    • Handle: RePEc:spr:reaccs:v:2:y:1998:i:4:d:10.1023_a:1023688704798
    DOI: 10.1023/A:1023688704798
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    References listed on IDEAS

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    1. Stephen H. Penman & Theodore Sougiannis, 1998. "A Comparison of Dividend, Cash Flow, and Earnings Approaches to Equity Valuation," Contemporary Accounting Research, John Wiley & Sons, vol. 15(3), pages 343-383, September.
    2. Ohlson, J.A. & Zhang, X.-J., 1997. "On the Theory of Forecast-Horizon in Equity Valuation," Papers 97-14, Columbia - Graduate School of Business.
    3. Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
    4. Stephen H. Penman, 1998. "Combining Earnings and Book Value in Equity Valuation," Contemporary Accounting Research, John Wiley & Sons, vol. 15(3), pages 291-324, September.
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    Cited by:

    1. Dennis Chambers & Ross Jennings & Robert B. Thompson, 1999. "Evidence on the Usefulness of Capital Expenditures as an Alternative Measure of Depreciation," Review of Accounting Studies, Springer, vol. 4(3), pages 169-195, December.
    2. Jeffery Abarbanell, 1999. "Discussion of “Evidence on the Usefulness of Capital Expenditures as an Alternative Measure of Depreciation”," Review of Accounting Studies, Springer, vol. 4(3), pages 197-203, December.

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