Potential dividends versus actual cash flows in firm valuation



I read the joint paper of Ignacio Velez-Pareja (IVP) with CA Magni, Potential Dividends vs Actual Cash Flows in Firm Valuation.

My comments:

There are no examples shown by authors how to get Actual Cash Flows…as this is about Forecast then there is such thing called Actual.

Probably what I capture from this paper. The authors want that the investment policy and payout policy for the excess cash is explicitly spelled out. Instead of assuming all Excess Cash be distributed as dividends.

The investment policy for excess cash will have the same impact as all distributed as dividends if the excess cash be put into zero NPV activities. For this statement. I am not really clear since in many valuation exercises during forecast mostly return is higher that WACC (abnormal then slowing down to normal or competitive margin).

Zero NPV activities also raise a question..as it is hard to imagine the company want to invest in such thing.

Excess cash in many cash be retained for “temporary” reason, for example, in Apple, to anticipate legal claims, to execute Acquisition, etc. Ultimately, it will go down to shareholders..this could be seen in Microsoft and Apple cases.

Excess cash should not be a norm in many companies. It could be high in certain period if there is a potential liquidity crises in financial market as management decides to keep the excess cash for a time being until the threat is lifted out.

As forecast is for long term view. Will this potential cash flow vs actual one will be a big difference to valuation? Or the error of not doing will have big impact? To answer this. Again I don’t see any example in numbers be shown by the authors.




The idea of that paper on potential dividends is simply that when calculating CFs you should take into account working capital including cash in hand and excess cash as ST investments if any.



I guess excess cash is not a spontaneous one, like Trade receivables or any operating cash.  This is a discretionary element. If it is considered too big, management could distribute it by increasing the payout ratio.




Yes, it can. But I wonder if you as analyst should decide that. It is a decision of the board of directors. 

If you are an analyst and forecast the CFs probably you don’t acummulate cash permanently. Hence, in general, cash and ST investments shoud be included in the working capital and forget the idea promoted by Damodaran of Potential Dividends.

When forecasting you can (as I do in my model) define a cash hold policy, a distribution policy (payment of dividends or Net Income), and a mechanism (see module 5 in our model) of investing temporary any excess cash that could be found. The policy IS NOT or SHOULD NOT to accumulate cash, in general. In any case, if the firm decides to hold cash it is a decision that destroys value and should be reflected in the CFs and hence in Value. 

In the model we have 5 modules: 

Module 1. Operating income and expenses

Module 2. Investment module

Module 3 Financing module: defines amounts of debt to be taken and payments of principal and interest

Module 4 Equity module:  amount od equity to be invested by owners and dividends payments

Module 5 Excess cash definition.

In Mod 3 and 4 we define the size of the deficit and we increase it by the amount of cash in hand, otherwise, your minimum end cash would be zero. Mod 5 defines if there is superavit that is decreased by the minimum cash desired. Otherwise the minimun cash in hand would be zero.

Minimum cash is defined by policy. The greater the cash in hand, the lower firm value. Defining the level of cash should be an issue to be formally studied. You can explore the firm history to see what final cash is compared, say with revenues or with expenses and based on that you define the policy as a % of one of them



Including excess cash into working capital movement comes with a cost. The amount of working capital then doesn’t make sense anymore…too big?

About the BOD (Board of Directors)’s decision, the shareholders could push the BOD to distribute the excess cash in dividends or share buy-backs. Remember FCF theory behind Acquisitions and Buy-outs in mid 1980s. The company holds too much cash.

Anyway, the issue is how to determine the elements of unlevered cash flows generated by the project, assuming that the project is financed entirely by equity.

Is excess cash of part of that?

Seems so..if this is generated by Operating Assets entirely.



Yes, few months ago I sent the complete model.

Except ST debt, you can model the project with 100% equity and this yields zero LT debt in Module 3. If you wish not to include ST, I will have to double check the model. I have to try it.

The behavior of the model is that when there is debt, then no excess cash to invest. It would make no sense to invest excess cash while paying interest on debt.



In reality, there is a cash called compensating balance in which company keeps paying interest on debt while keeping deposit in the same bank. Or, a company has a borrowing facility with a bank which loan facility requires the borrower to have their cash management be handled by the same bank lender, which means the borrower has to keep their current account and any excess money with the same bank.

So this is not uncommon thing.




Yes, that could be a condition from the bank. However, if the bank requires the same amount as collateral it makes no sense to borrow money from it.




November 2018




BVR Yearbook翻译整理(一)

Here I got one pdf file from IACVA (China) which a compilation of selected articles from Business Valuation Resources, translated to Chinese by IACVA (China).

The BVR Yearbook contains some interesting articles about valuation issues and views from some leading valuation expert, such as Damodaran and the new Implied Private Company Pricing Line (IPCPL) introduced by Bob Dohmeyer, Pete Butler and Rod Burkett.

Those selected articles are as follows:


  1. Alternative Model Uses Corporate Bond Yields to Measure a Size Premium
  2. A Fresh Look at Using the Income Approach to Valuing FLPS
  3. Does the Size Effect Still Exist? New Analysis from Pratt and Grabowski
  4. Damodaran Discusses Value Versus Price and His View of the BV World
  5. Damodaran’s Warning Signs that Valuer is becoming a Pricer
  6. How Do You Value a Business that also Owns Real Estate?
  7. Help Clients Squeeze the Most Value of M&A Synergy
  8. The Implied Private Company Pricing Line 2.0
  9. Getting Your Head Out of the Model Valuing a Multi National Company
  10. A Forgotten Statistical Concept Tells Why Your Multiple May be Wrong
  11. 10 Time-Tested Ways to Build a Defensible Divorce Valuation
  12. U.S. Tax Court Judge Laro Discusses Valuation and Expert Testimony Issues
  13. Trade Associations Can Be Excellent Sources of Compensation Data
  14. A Preview of the New Benchmark Resource for Industry Cost of Capital
  15. Opportunities and Special Considerations in the Valuation of Hotels



I just read three recent articles on EBITDA.


  1. https://www.toptal.com/finance/financial-analysts/ebitda?utm_source=linkedin&utm_medium=HBR&utm_campaign=EBITDA


2. https://www.toptal.com/finance/financial-analysts/ebitda?utm_source=linkedin&utm_medium=HBR&utm_campaign=EBITDA


3. https://www.forbes.com/sites/brentbeshore/2014/11/13/ebitda-is-bs-earnings/#33e54b1d6070

Quite interesting to see how EBITDA got challenged though it is used widely in the valuation. EBITDA so far is still seen as a clean measure of what the business has generated, separate from its capital or financing structure and investment. Since we are more interested in the risk of the company’s underlying business operations, then EBITDA seems to me, is relevant to use.


Comments from Ignacio Velez-Pareja:

You might guess what I think of EBITDA.

First of all, I prefer to show THREE financial statements: CB, P&L and BS.

When you do that, you have the best shortcut to CF: CCF = CFD+CFE and these two are seen directly in the CB as the negative of the financing module (3) and the equity transactions module (4). That’s it.

I think that valuation by multiples is still a questionable.

I do calculate multiples just to compare the calculated value with real transactions, not the contrary. I mean, multiple calculation should be done AFTER, valuation (DCF) in order to be compared with similar transactions. I just remember one firm that approached us saying that they were offered to buy the firm by 7 x EBITDA and asked if we could give an opinion on that. We said we had NFI if it was good or not to sell it to the English firm that made the offer. We explained the idea of DCF and that after that we could give our opinion. In short, we valuated the firm, we were very critical and conservative to any input to be included, such as real growth rates and real price increases and we found that EV/EBITDA might range between 12-17. After a couple of years I met the owners and they told me they didn’t accept the offer and that our estimate of multiple was still conservative. They were very happy with their decision not to sell.

Regarding the terminal value, TV, yes, it might be a Pandora’s Box. We usually have 3 estimates for TV: Invested Capital at year N, non-growing perpetuity and growing perpetuity. We try that PV(TV) is around 20%-30% of EV.

Bottom line: I stick to DCF.

Best regards

Note from Karnen: DCF is of course, the most “technical” analysis, compared to the other techniques in the Valuation for M&A, they are Comps and Precedent Transactions. However, the necessity to use Perpetuity in the DCF analysis is still quite problematic as it could take as much as 80% of the Enterprise Value analysis.

IPO Valuation – A Quick Communication with Prof. Peter M. DeMarzo (Stanford Graduate School of Business, USA)

Hi Prof. Peter,

I am referring to the 4th Edition of the Corporate Finance textbook (https://www.amazon.com/Corporate-Finance-4th-Pearson-Standalone/dp/013408327X),

Chapter 23 under 23.2 “The Initial Public Offering”, section “valuation” which said:

Before the offer price is set, the underwriters work closely with the company to come up with a price range that they believe provides a reasonable valuation for the firm using the techniques described in Chapter 9. As we pointed out in that chapter, there are two ways to value a company: estimate the future cash flows and compute the present value, or estimate the value by examining comparable companies. Most underwriters use both techniques. However, when these techniques give substantially different answers, they often rely on comparables based on recent IPOs.

However, when looking into Chapter 9, I do not find any mention about pre-money and post-money valuation.

Normally, for IPO purposes, since the company is going to issue new shares to be offered to the public, instead of the existing shareholders selling their shares to the public (Note: they could do so, post IPO, and there could be a lock-up period, let’s say, one year in certain country, for existing shareholder to be not being able to sell their shares), it is important to see how much the value of the company before and after the IPO proceeds flowing into the company’s bank account. The planned use of the IPO proceeds will be required to be disclosed in the prospectus and this will impact the IPO valuation, as the analyst needs to assess how much the added value of that use to the whole valuation.


The reply from Prof. Peter

Hi Karnen,

Yes, it is a good point worth mentioning that the value will be based on the anticipated future cash flows given any new investment.  (Alternatively, the new cash raised will contribute to the equity value over and above existing enterprise value.)

Thanks again,



Karnen’s responses:

Hi Prof. Peter,

This IPO valuation (or pricing in reality in view of limited number of shares being put on offer for sales to the public, resulting in the working of demand and supply law) is really interesting, though I see the Corporate Finance textbook is quite little in bringing to really appreciate it.

This IPO pricing is essentially about what the company would like to do with the IPO proceeds.

In general, we could separate the use of that IPO proceeds into:

  1. Financing a project/business totally separated from the company’s existing projects/business.
  2. Financing/refinancing current business, for example, the expansion in the same business line (opening more stores, financing working capital, capital expenditures), and/or paying down the bank loans
  3. The combination of No. 1 and No. 2 above.

In the case of No. 1 above, and assuming there is no positive/negative synergy with the current business/project, then the IPO pricing will really look into the added value (=NPV) of that new ventures divided by the number of newly issued shares.

In the case of No. 2 above, then we need to look at the equity value after being added with the NPV brought in by the expansion, etc., after factored into the valuation, the plus and minus of the synergy value. As a note, the NPV of the project will ultimately go to the equity shareholders or investors (Note: NPV project = NPV investors only holds if market value of the debt is identical to book value of the debt. If the debt is traded one, such as bonds, then this could not hold). Then the IPO pricing is the new equity value divided by the total number of common shares (current shares + new shares).

Jakarta, August 2017