Actual and Potential Dividends: Reconciling Theory and Practice
Actual and Potential Dividends: Reconciling Theory and Practice

Summary/Abstract: The concept of potential dividends (PD) and its application in valuation models have been subjectto an active debate. The opponents of the inclusion of PD into free cash flow to equity point out thelogical inconsistencies and theoretical flaws of the concept, while advocates argue that ignoring the PD invalue estimation may cause the results to be biased. I argue that while under rigorous assumptions of theModigliani-Miller theory the PD concept may appear to be disputable, it represents an important part ofthe valuation model as soon as those assumptions are relaxed to allow for deviations commonly observedin practice. The aim of the paper is to present guidance to the application of PD and actual dividends (AD)concepts in valuation models. I maintain that each of the two methodologies can be used only in the specificallypredefined contexts, which are described in the paper. Ultimately, the paper attempts to make practicalrecommendations regarding the application of the PD and AD concepts in valuation.

• Details
• Contents