Article Discusses how different estimates of equity value are obtained by researchers while using the discounted cash flow model (CB) and the Residual income (RI) model. It recognizes the inconsistencies prevalent while implementing them. Francis et al (2000) use Value line estimates for finite forecasting periods. They conclude that RI is superior to CB. Courteous et al (2000) analyses whether different valuation models are same when a terminal value calculation based on price is used. They conclude that RI is dominant to CB when terminal price forecasts are not obtainable.
Penman and Sogginess (1998) examine the differences in model estimates by using a portfolio of ex post realizations of financial statement data. They conclude that methods based on projecting GAP accrual earnings give lower valuation errors than forecasting cash flows. The inconsistent forecasts error occurs when there is an error in the starting value of the terminal value perpetuity. In order to prevent this error, a financial statement forecast in the terminal period using the terminal growth rate has to be developed and the relevant valuation attribute In the year T + 1 should be constructed.
This error is experienced in all three papers. The inconsistent discount rate error arises due to inconsistency between cost of equity capital and weighted average cost of capital. This error is experienced by Francis and Penman. The missing cash flow error exists due to an inconsistent way of calculating the valuation attributes. Courteous and Francis suffer this error. Therefore this article argues that Uri’s superiority over CB is mistaken and disproves the commonly held notion that practical implementation Issues cause differences In the RI and CB models which are equivalent theoretically and empirical comparison Is worthwhile.
In order to get the same value estimates for each model proper care should be taken while using financial statements In Article 2, the paper by Lunchroom and O’ Kef states that research efforts In valuation could be spent on a study of how to make accurate financial statement data forecasts Instead of how to represent and discount the values. The author disagrees to this paper and argues that valuation research helps create products that facilitate analysis. The paper does not consider accrual accounting but the author thinks that we cannot be cynical and need to understand he Issue to reject or Justify accrual accounting.
This paper dismisses empirical comparison which proves that GAP accrual accounting has advantages over cash accounting. In Article 3, Penman provides three criticisms against the Contemporary Accounting Research. Firstly, forecasts are made only up to a fleet horizon and this causes an error In the practical Implementation of the theoretical model. The authors argue that this constraint cannot create a difference If calculated properly. Secondly, arriving at the correct growth rate In the terminal period and knowing If It applies to ash flows or RI flows are empirical questions. The authors only agree to the first part of this statement.
Finally, results only hold good when all attributes are In a steady state. Cash flow By Nonsensicalness 23 Article 1 discusses how different estimates of equity value are obtained by terminal growth rate has to be developed and the relevant valuation attribute in the notion that practical implementation issues cause differences in the RI and CB models which are equivalent theoretically and empirical comparison is worthwhile. In states that research efforts in valuation could be spent on a study of how to make accurate financial statement data forecasts instead of how to represent and discount the issue to reject or Justify accrual accounting.