Equivalent valuations in cash flow and accounting models

Richard Sweeney ()

Review of Quantitative Finance and Accounting, 2014, vol. 42, issue 1, 29-49

Abstract: This paper investigates the equivalence of equity valuation between the free cash flow model and the residual income model. Two conditions are found to be jointly sufficient for Residual Income and Free Cash Flow models to produce the same equity valuation: (a) the models’ discount rates jointly satisfy the Modigliani and Miller (Am Econ Rev 48:261–297, 1958) condition which relates discount rates for levered equity, unlevered equity, tax savings and debt, and (b) forecasts of the two models’ variables jointly satisfy the income statement and balance sheet identities. Past discussions fail by ignoring or misusing (a). Copyright Springer Science+Business Media New York 2014

Keywords: Cash-flow valuation models; Residual income models; Dividend discount rates; Accounting identities; G11; C52; M41 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1007/s11156-012-0332-x

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