Explaining the Equivalence of

Explaining the Equivalence of Valuation Models and the Relevance of Earnings

Module 13 focused on the discounted cash flow (DCF) model and Module 14 focused on the residual

operating income (ROPI) model. The models focus on free cash flows to the firm and on residual operating income, respectively. We stressed that these two models are theoretically equivalent.

 a. What is the initiation for why these models are equivalent?

b. Under what conditions might the two models yield different stock prices for the same firm?

c. Some analysts focus on cash flows as they believe that companies manage earnings, which presumably makes earnings less relevant. Are earnings relevant? Explain.

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