Abstract
Due to the possible deferral of capital gains taxes, retaining earnings provide a tax advantage compared to distributing them. Because of this, the calculation of the terminal value is often based on the assumption of an exogenously determined payout ratio. The present study considers this assumption and develops a valuation model for the case in which the firm pursuits an active debt management, that is, adopts a financing policy based on market values. The terminal value is determined under both free cash flow and flow to equity approaches. Overall, it is shown that the valuation formula used in standard practice does not take into account all the financial effects caused by the retention of earnings. A simulation of the valuation error highlights that the value contribution of the dividend policy is overestimated by more than 25% on average. This result points out the need to carefully rethink the currently employed approaches to terminal value calculation.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
