Module 30.1 LOS 30.n: When FCFE is Preferred, Ownership Perspective Implication of FCFE

The ownership perspective in the free cash flow approach is that of an acquirer who can change the firm’s dividend policy, which is a control perspective, or for minority shareholders of a company that is in-play. The ownership perspective implicit in the dividend discount approach is that of a minority owner who has no direct control over the firm’s dividend policy.

Analysts often prefer to use free cash flow rather than dividend-based valuation for the following reasons:

  • Many firms pay no, or low, cash dividends.
  • Dividends are paid at the discretion of the board of directors.
  • If a company is viewed as an acquisition target, free cash flow is a more appropriate measure because the new owners will have discretion over its distribution (control perspective).
  • Free cash flows may be more related to long-run profitability of the firm as compared to dividends.

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