the value using the dividend discount model can be
considered one component of the value of controlling a
firm—itmeasuresthevalueofcontrollingdividendpolicy.In
ahostiletakeover,thebiddercanexpecttocontrolthefirm
and change the dividend policy (to reflect FCFE), thus
capturing the higher FCFE value.
Asforwhichofthetwovaluesisthemoreappropriateonefor
use in evaluating the market price, the answer lies in the
openness ofthemarket for corporate control.If there isa
sizable probability that a firm can be taken over or its
management changed, the market price will reflect that
likelihoodandtheappropriatebenchmarktouseisthevalue
from the FCFE model. As changes in corporate control
becomemoredifficultbecauseofafirm’ssizeand/orlegalor
marketrestrictionsontakeovers,thevaluefromthedividend
discountmodelwillprovidetheappropriatebenchmark for
comparison.
ILLUSTRATION5.10: Equivalence(or Not)ofFCFEand
DDM Models
Toillustratetheimplicitassumptionsthatweneedto make
forthedividenddiscountandFCFEmodelstoconverge,let
usconsiderahypotheticalcompany.TivoliEnterprisespaid
outdividendsof$30milliononnetincomeof$100millionin
themostrecentfinancialyear;revenueswere$1,000million
for the year. During the same year, capital expenditures
amountedto$75million,depreciationwas$50million,and
noncash working capitalwas 5%of revenues. Inaddition,
newdebtissuesexceededdebtrepaymentsby $10million.
Finally,letusassumethatthefirmhadnocashonhandatthe
time of the valuation.