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A Reconsideration of Tax Shield Valuation

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  • Enrique R. Arzac
  • Lawrence R. Glosten
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    Abstract

    "A quarter-century ago, Miles and Ezzell (1980) solved the valuation problem of a firm that follows a constant leverage ratio L = D/S. However, to this day, the proper discounting of free cash flows and the computation of WACC are often misunderstood by scholars and practitioners alike. For example, it is common for textbooks and fairness opinions to discount free cash flows at WACC with beta input β" S = [1 + (1   -  "τ")"L"]"β" "u" , "although the latter is not consistent with the assumption of constant leverage. This confusion extends to the valuation of tax shields and the proper implementation of adjusted present value procedures. In this paper, we derive a general result on the value of tax shields, obtain the correct value of tax shields for perpetuities, and state the correct valuation formulas for arbitrary cash flows under a constant leverage financial policy." Copyright Blackwell Publishers Ltd, 2005.

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    Bibliographic Info

    Article provided by European Financial Management Association in its journal European Financial Management.

    Volume (Year): 11 (2005)
    Issue (Month): 4 ()
    Pages: 453-461

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    Handle: RePEc:bla:eufman:v:11:y:2005:i:4:p:453-461

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    Cited by:
    1. M. Levati & Jianying Qiu & Prashanth Mahagaonkar, 2012. "Testing the Modigliani-Miller theorem directly in the lab," Experimental Economics, Springer, vol. 15(4), pages 693-716, December.
    2. Assaf Eisdorfer, 2012. "The firm-specific nature of debt tax shields and optimal corporate investment decisions," Managerial Finance, Emerald Group Publishing, vol. 38(6), pages 560-570, May.
    3. Cooper, Ian & Nyborg, Kjell G, 2005. "The Value of Tax Shields IS Equal to the Present Value of Tax Shields," CEPR Discussion Papers 5182, C.E.P.R. Discussion Papers.
    4. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "Miller's (2009) WACC model: An extension," Working Paper Series 1995, Victoria University of Wellington, School of Economics and Finance.

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