Final answer:
The statement that dividends-based valuation cannot be used for firms that do not pay dividends is false. While typically used for dividend-paying companies, alternate valuation methods like the Free Cash Flow to Equity or Residual Earnings Model can assess the value of non-dividend-paying firms. These methods can provide a framework for estimating potential investor returns.
the correct option is approximately option B
Step-by-step explanation:
The statement that “the dividends-based valuation approach cannot be used for firms that do not pay dividends” is false. While the dividends-based valuation approach, specifically the Dividend Discount Model (DDM), is primarily used for companies that pay regular dividends, there are other methods to value companies that do not. One such alternative is the Free Cash Flow to Equity (FCFE) model, which estimates the value of equity as the present value of future cash flows that could be paid to shareholders as dividends, even if the company does not pay them currently.
The use of DDM presumes that dividends are the expected cash flows for a shareholder; however, in the absence of dividend payments, a firm may still funnel earnings back into the company for growth, which in turn can increase the company's value and consequently the stock price. This increase in price can provide returns to shareholders similar to dividends. Thus, for companies that do not pay dividends, investors should turn to other valuation methods like FCFE or the Residual Earnings Model, which focus on other aspects of a company's financial health and potential for growth.
In conclusion, the ability to use a dividends-based valuation approach for a non-dividend-paying company depends on the assumptions and modifications made to the model. Should an investor be able to estimate the potential dividends that could be paid or adjust the model for earnings reinvestment, it is theoretically possible to use dividends-based valuation as a framework to value these companies as well.