###### Earnings Normalization and Cash Flow E ...

Private company valuations may require adjustments to estimate the company's normalized earnings as... **Read More**

The free cash flow valuation approach is preferred over the dividend discount model (DDM) because:

- Many corporations pay no or minimal cash dividends. Using the DDM would require assuming a period in the future when dividends will be paid, the amount that will be paid, and its growth rate.
- Dividends are at the discretion of the corporation’s board of directors. The dividends may therefore not signal the company’s long-run profitability.
- Dividends are cash flows going to shareholders, while FCFE is the cash flow available to shareholders without impairing the company’s operations. Therefore, it takes a minority shareholder perspective. If a company is being evaluated because it’s a takeover target, a free cash flow measure is more appropriate.

## Question

Which of the following valuation models is

most appropriatewhen valuing a company from a minority shareholder perspective?

- FCFE model.
- FCFF model.
- Dividend discount model.
## Solution

The correct answer is C.The dividend discount model is the most appropriate valuation model when valuing a company from a minority shareholders’ perspective.

A is incorrect.The FCFE model is appropriate when valuing a company from a majority shareholder’s perspective.

B is incorrect.FCFF is also be used to value the firm from a majority shareholder’s perspective.

Reading 24: Free Cash Flow Valuation

*LOS 24 (f) Compare the FCFE model and dividend discount models.*