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Earnings, Book values, and Dividends in equity valuation

Earnings, Book values, and Dividends in equity valuation. Ohlson (1995 ) Contemporary Accounting Research. Model Assumptions. a. PVED b. Equity Accounting Constructs c . Information Dynamics Linear , Closed-form Valuation Model ( Ohlson Model). Assumption 1 – PVED.

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Earnings, Book values, and Dividends in equity valuation

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  1. Earnings, Book values, and Dividends in equity valuation Ohlson (1995) Contemporary Accounting Research

  2. Model Assumptions a. PVED b. Equity Accounting Constructs c. Information Dynamics Linear, Closed-form Valuation Model (Ohlson Model)

  3. Assumption1 – PVED • Market value of the firm equal to the present value of net future expected dividends

  4. Assumption2 – Clean Surplus Relationship (CSR) Clean Surplus Relationship (CSR)- Dividends reduce book value without affecting current earnings Dividend reduces book value Dividend doesn’t influence current earnings

  5. Assumption2 – Clean Surplus Relationship (CSR) • Replace expected dividends with book value and abnormal earnings to express firm’s market value • Define • Combing (A2a), yield • Links value with observable accounting data and abnormal earnings reconcile the difference between book value and market value

  6. Assumption 3 – Information Dynamics • Stochastic time-series behavior of abnormal earnings • Vt: value relevant information other than abnormal earnings • 0≤ω,γ<1. Persistency parameters capturing abnormal earnings’ persistency. • Higher ω/γ higher stationarity

  7. Assumption 3 – Information Dynamics Three Implications: a. Abnormal earnings follow AR(1) b. Other information follows AR(1) c. Other information incorporated into earnings with one lag and impact gradually feed into future abnormal earnings

  8. Ohlson Model • Based on (A1), (A2a), (A3) and (1), yield • No longer need explicit forecast of future dividends • Information dynamics allows value to be expressed as a function of contemporaneous data

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