Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

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work with assumptions about dollar debt rather than debt
ratios, you can switch to the adjusted present value approach.


In valuing equity, wecan discountdividends or freecash
flows to equity. We should consider using the dividend
discount model under the following circumstances.



  • Wecannotestimatecash flowswith anydegree of
    precision, either because we have insufficient or
    contradictory informationaboutdebt paymentsand
    reinvestmentsor because wehave trouble defining
    whatcomprisesdebt.Thiswasourrationaleforusing
    dividend discount models for valuing financial
    services firms.

  • Therearesignificantrestrictions onstockbuybacks
    andotherformsofcashreturn,andwehavelittleor
    nocontroloverwhatthemanagementofafirmdoes
    withthecash.Inthiscase,theonlycashflowswecan
    expect to get from our equity investment are the
    dividends that managers choose to pay out.


Inallothercases,wewillgetmuchmorerealisticestimatesof
afirm’svalueusingthefreecashflowtoequity,whichmay
be greater than or lower than the dividend.


Should We Use Current or Normalized Earnings?


In most valuations, we begin with the current financial
statementsofthefirmandusethereportedearningsinthose
statementsasthebaseforprojections.Therearesomefirms,
though,wherewemaynotbeabletodothis,eitherbecause
thefirm’searningsarenegativeorbecausetheseearningsare

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