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Firm valuation with state dependent COD taxation

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  • Fischer, Max
  • Krause, Marko
  • Lahmann, Alexander
  • Stimper, Franziska

Abstract

Standard models on firm valuation, incorporating risky debt, assume a certain tax treatment of a cancellation of indebtedness (COD). Most valuation procedures solely discuss two polar cases: either the COD is strictly taxed on its entirety or not taxed at all. Considering the predominant national tax jurisdictions in G7 and many other countries, this assumption is far from being realistic. We model a state dependent taxation of a COD considering the firm's state in default and further contingencies, including a partial taxation. We show how to include this stochastic interdependency into the pricing of the value of the tax shield and the WACC. Compared to the case of full taxation of a COD this potentially increases the value of tax savings and decreases the discount rate, since less taxes are paid in states with exceptions of a tax on a COD, vice versa for the case of no taxation on a COD. Furthermore, in case of an exemption from taxation of a COD, pricing equations depend on the distribution of total losses on interest and principal payments.

Suggested Citation

  • Fischer, Max & Krause, Marko & Lahmann, Alexander & Stimper, Franziska, 2022. "Firm valuation with state dependent COD taxation," The Quarterly Review of Economics and Finance, Elsevier, vol. 84(C), pages 550-561.
    • Handle: RePEc:eee:quaeco:v:84:y:2022:i:c:p:550-561
    DOI: 10.1016/j.qref.2020.10.012
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    References listed on IDEAS

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    More about this item

    Keywords

    Risky debt; Tax treatment of cancelled debt; COD; Tax savings; WACC;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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