Cash Flow Measures - Dividends

Overview

The first issue that needs to be tackled in a discounted cash flow analysis is what measure of cash flow to use. The firm is owned by the shareholders, so the value of the firm is the value that accrues to the shareholders. From this perspective, the appropriate measure of cash flow would be dividends paid by the firm its shareholdes.

Challenges

• Firms that dont pay dividends - some firms do no pay dividends. This can be for various reasons
  • The firm is in a growth phase in which all of its earnings are re-invested
  • The firm is in a risky sector for which it retains all of it's earnings in an attempt to create a security buffer.
  Firms that dont pay dividends are still valuable, even if they plan to never pay dividends. (For example, the firm could be purchased at some future date, realizing its value to its shareholders.)
• Forecasting dividends pose the same challenges as forecasting any other time series. A simple model is to take the current dividend and apply a forecasted growth rate. (the forecasted growth rate is sometimes taken to be the average growth rate from the past)