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USING EARNINGS AND FREE CASH FLOW TO EVALUATE CORPORATE PERFORMANCE

USING EARNINGS AND FREE CASH FLOW TO EVALUATE CORPORATE PERFORMANCE Footnotes 1 P. Dechow, “Accounting Earnings and Cash Flows as Measures of Firm Performance: The Role of Accounting Accruals,” The Journal of Accounting and Economics (1994). 2 Construction of a measure of firm performance requires consideration of (1) future free cash flow, (2) the size of the investment base, and (3) the cost of capital. In this article, I restrict my focus to the ability of current earnings and current free cash flow to predict future free cash flow. Note that because I compare earnings and free cash flow using the exact same sample of firms, the size of the investment base and the cost of capital are held constant. The reason I scale by total assets is to avoid giving too much weight to large firms in my results. 3 For simplicity, I assume an all‐equity capital structure and use the term “dividends” to refer to the net cash distributions made to all equity holders. 4 Of course, in cases where capital expenditures are relatively large and irregular, the timing of future cash flows can also be an important value driver (for example, a utility with a small number of facilities). 5 For example, Stern Stewart & http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Applied Corporate Finance Wiley

USING EARNINGS AND FREE CASH FLOW TO EVALUATE CORPORATE PERFORMANCE

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Publisher
Wiley
Copyright
Copyright © 1996 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1078-1196
eISSN
1745-6622
DOI
10.1111/j.1745-6622.1996.tb00103.x
Publisher site
See Article on Publisher Site

Abstract

Footnotes 1 P. Dechow, “Accounting Earnings and Cash Flows as Measures of Firm Performance: The Role of Accounting Accruals,” The Journal of Accounting and Economics (1994). 2 Construction of a measure of firm performance requires consideration of (1) future free cash flow, (2) the size of the investment base, and (3) the cost of capital. In this article, I restrict my focus to the ability of current earnings and current free cash flow to predict future free cash flow. Note that because I compare earnings and free cash flow using the exact same sample of firms, the size of the investment base and the cost of capital are held constant. The reason I scale by total assets is to avoid giving too much weight to large firms in my results. 3 For simplicity, I assume an all‐equity capital structure and use the term “dividends” to refer to the net cash distributions made to all equity holders. 4 Of course, in cases where capital expenditures are relatively large and irregular, the timing of future cash flows can also be an important value driver (for example, a utility with a small number of facilities). 5 For example, Stern Stewart &

Journal

Journal of Applied Corporate FinanceWiley

Published: Mar 1, 1996

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