**SSE/EFI Working Paper Series in Business Administration**
# No 2007:11:

The Abnormal Earnings Growth Model: Applicability and Applications

*L. Peter Jennergren *()

* and Kenth Skogsvik *()

**Abstract:** We investigate a disaggregated version of the abnormal
earnings growth (AEG) model of Ohlson and Juettner-Nauroth (2005). The
value of the firm then becomes discounted free cash flows minus initial
debt. Discounted free cash flows are equal to capitalized operating
earnings from the initial stock of operating assets plus the present value
of an infinite sequence of growth projects, where each growth project is
valued by discounted economic value added. Sufficient conditions for the
present value of the free cash flows to be equal to the sum of these two
components are investigated. The Gordon growth formula is found to be one
special case. Another case concerns lumpy growth projects with depreciation
according to the annuity method. We then allow for three different interest
rates, the required rate of return on equity under all-equity financing,
the borrowing rate, and the required rate of return on equity under partial
debt financing (the latter given by MM's Proposition 2). In the model of
Ohlson and Juettner-Nauroth, these rates are the same. A firm-level model
is developed that focuses on operating earnings and free cash flows with
discounting at the required rate of return under all-equity financing. An
equity-level model is then developed that focuses on bottom-line earnings
and dividends with discounting at the required rate of return under partial
debt financing. Relationships between the two models are explored. Dividend
policy irrelevance holds only in a limited sense for the equity-level
model.

**Keywords:** Financial analysis; abnormal earnings growth model; dividend policy; discounted dividends; discounted free cash flows; capitalized earnings; discounted economic value added; (follow links to similar papers)

28 pages, September 28, 2007

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