Terminal Value Calculation with Constant Payout Ratio and Active Debt Management

17 Pages Posted: 18 Jul 2019

See all articles by Ralf Diedrich

Ralf Diedrich

University of Leipzig

Stefan Dierkes

Georg August Universität

Evelyn Raths

Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft

Johannes Sümpelmann

University of Goettingen (Göttingen)

Date Written: June 18, 2019

Abstract

Due to the possible deferral of capital gains taxes, retaining earnings provide a tax advantage compared to distributing them. Because of this, the calculation of the terminal value is often based on the assumption of an exogenously determined payout ratio. The present study considers this assumption and develops a valuation model for the case in which the firm pursuits an active debt management, that is, adopts a financing policy based on market values. The terminal value is determined under both free cash flow and flow to equity approaches. Overall, it is shown that the valuation formula used in standard practice does not take into account all the financial effects caused by the retention of earnings. A simulation of the valuation error highlights that the value contribution of the dividend policy is overestimated by more than 25% on average. This result points out the need to carefully rethink the currently employed approaches to terminal value calculation.

Keywords: Corporate valuation, Terminal value, Dividend policy, Constant payout ratio, Financing policy

JEL Classification: G32, H20, M41

Suggested Citation

Diedrich, Ralf and Dierkes, Stefan and Raths, Evelyn and Sümpelmann, Johannes, Terminal Value Calculation with Constant Payout Ratio and Active Debt Management (June 18, 2019). Available at SSRN: https://ssrn.com/abstract=3422316 or http://dx.doi.org/10.2139/ssrn.3422316

Ralf Diedrich

University of Leipzig ( email )

Stefan Dierkes (Contact Author)

Georg August Universität ( email )

Platz der Göttinger Sieben 5
Göttingen, DE 37073
Germany

Evelyn Raths

Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft ( email )

Stuttgart
Germany

Johannes Sümpelmann

University of Goettingen (Göttingen) ( email )

Platz der Goettinger Sieben 3
Goettingen, 37073
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
54
Abstract Views
682
rank
459,388
PlumX Metrics