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Extended Dividend, Cash Flow and Residual Income Valuation Models - Accounting for Deviations from Ideal Conditions

56 Pages Posted: 19 Jun 2008 Last revised: 4 Jun 2011

Nicolas Heinrichs

University of Cologne - Graduate School of Risk Management

Dieter Hess

University of Cologne - Department of Corporate Finance; University of Cologne - Centre for Financial Research (CFR)

Carsten Homburg

University of Cologne

Michael Lorenz

University of Cologne

Soenke Sievers

University of Paderborn - Faculty of Business Administration, Economics and Business Computing

Multiple version iconThere are 2 versions of this paper

Date Written: April 9, 2009

Abstract

Standard equity valuation approaches (i.e., DDM, RIM, and DCF model) are derived under the assumption of ideal conditions, such as infinite payoffs and clean surplus accounting. Because these conditions are hardly ever met, we extend the standard approaches, based on the fundamental principle of financial statement articulation. The extended models are then tested empirically by employing two sets of forecasts: (1) analyst forecasts provided by Value Line and (2) forecasts generated by cross-sectional regression models. The main result is that our extended models yield considerably smaller valuation errors. Moreover, by construction, identical value estimates are obtained across the extended models. By reestablishing empirical equivalence under non-ideal conditions, our approach provides a benchmark that enables us to quantify the errors resulting from individual deviations from ideal conditions, and thus, to analyze the robustness of the standard approaches. Finally, by providing a level playing field for the different valuation approaches, our findings have implications for other empirical settings, for example, estimating the implied cost of capital.

Keywords: Dividend Discount Model, Residual Income, Discounted Cash Flow, Dirty Surplus, Terminal Value, Valuation Error

JEL Classification: G12, G14, M41

Suggested Citation

Heinrichs, Nicolas and Hess, Dieter and Homburg, Carsten and Lorenz, Michael and Sievers, Soenke, Extended Dividend, Cash Flow and Residual Income Valuation Models - Accounting for Deviations from Ideal Conditions (April 9, 2009). Available at SSRN: https://ssrn.com/abstract=1145201 or http://dx.doi.org/10.2139/ssrn.1145201

Nicolas Heinrichs

University of Cologne - Graduate School of Risk Management ( email )

Albertus-Magnus-Platz
Cologne, D-50923
Germany

Dieter Hess

University of Cologne - Department of Corporate Finance ( email )

Corporate Finance Seminar
Albertus-Magnus-Platz
D-50923 Cologne
Germany
+49 221 470 7876 (Phone)
+49 221 470 7466 (Fax)

HOME PAGE: http://cf.uni-koeln.de/

University of Cologne - Centre for Financial Research (CFR)

Germany

Carsten Homburg

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

Michael Lorenz

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

Soenke Sievers (Contact Author)

University of Paderborn - Faculty of Business Administration, Economics and Business Computing ( email )

Warburger Str. 100
D-33098 Paderborn
Germany

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