Potential Dividends Versus Actual Cash Flows in Firm Valuation
The ICFAI Journal of Applied Finance, Vol. 15, No. 7, pp. 51-66
24 Pages Posted: 8 Apr 2009 Last revised: 20 Dec 2010
Date Written: April 6, 2009
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with DeAngelo and DeAngelo (2006, 2007), we underline that cash flows create value for shareholders only if they are withdrawn from the firm, and that the use of potential dividends may lead to contradictions.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. Available at SSRN.
Keywords: Cash flows, cash flow to equity, liquid assets, potential dividends, firm valuation, equity value, Modigliani and Miller
JEL Classification: G12, G31, G35, M41
Suggested Citation: Suggested Citation