Reconciling Value Estimates from the Discounted Cash Flow Value Model and the Residual Income Model

33 Pages Posted: 13 Jul 2000

See all articles by Russell J. Lundholm

Russell J. Lundholm

University of British Columbia - Sauder School of Business

Terry O'Keefe

University of Queensland - Accounting and Accountability; University of Oregon - Department of Accounting

Date Written: November 15, 2000

Abstract

In this paper we investigate why the discounted cash flow model and residual income model frequently give different value estimates. We identify three common errors in the implementation of the models and show that these errors affect the models in different ways, creating differences in the value estimates that each produces. Our estimates of the size and direction of these errors roughly reconciles the observed differences in value estimates from papers attempting to "horse-race" the models. We also argue that any such contest is ill-conceived; given the same set of forecasted financial statements all models derived from the basic dividend-discounting assumption should yield the same value estimate. We discuss why claims of the residual income model's superiority over the discounted cash flow model, both on empirical and theoretical grounds, are misstated.

JEL Classification: M41, G12, G31, G32

Suggested Citation

Lundholm, Russell J. and O'Keefe, Terry, Reconciling Value Estimates from the Discounted Cash Flow Value Model and the Residual Income Model (November 15, 2000). Available at SSRN: https://ssrn.com/abstract=229445 or http://dx.doi.org/10.2139/ssrn.229445

Russell J. Lundholm (Contact Author)

University of British Columbia - Sauder School of Business ( email )

2053 Main Hall
Vancouver, British Columbia V6T 1Z2
Canada

Terry O'Keefe

University of Queensland - Accounting and Accountability ( email )

Brisbane 4072, Queensland
Australia

University of Oregon - Department of Accounting ( email )

Lundquist College of Business
1208 University of Oregon
Eugene, OR 97403
United States

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