Scandinavian Working Papers in Economics
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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Business Administration

No 2008:9:
The Abnormal Earnings Growth Model, Two Exogenous Interest Rates, and Company Taxes

L. Peter Jennergren () and Kenth Skogsvik ()

Abstract: In the abnormal earnings growth (AEG) model of Ohlson and Juettner-Nauroth (2005), there is one interest rate and no taxes. Their model focuses on bottom-line earnings and dividends and is hence viewed as an equity-level model. We first extend this model to a firm-level model based on operating earnings and free cash flows. We then allow for two exogenous interest rates: the required rate of return on equity under all-equity financing and the borrowing rate. A firm-level model is developed where dividends are discounted at the time-varying required rate of return on equity under partial debt financing. Using this firm-level model as a stepping stone, a new equity-level model is developed with dividends discounted at the required rate of return under partial debt financing. Dividend policy irrelevance holds. Finally, the firm-level and equity-level models are extended to a situation with company taxes. Dividend policy irrelevance then no longer holds.

Keywords: Financial analysis; abnormal earnings growth model; dividend policy; discounted dividends; free cash flow; (follow links to similar papers)

41 pages, December 19, 2008, Revised March 10, 2009

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This paper is published as:
Jennergren, L. Peter and Kenth Skogsvik, (2011), 'The Abnormal Earnings Growth Model, Two Exogenous Discount Rates, and Taxes', Journal of Business Finance & Accounting, Vol. 38, pages 505-535

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