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Value of tax shields and the risk of the net increase of debt, The. Year 2004

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  • Fernandez, Pablo

    ()
    (IESE Business School)

Abstract

The value of tax shields depends on the nature of the stochastic process of the net increase of debt; it does not depend on the nature of the stochastic process of the free cash flow. The value of tax shields in a world with no leverage cost is the tax rate times the debt, plus the tax rate times the present value of the net increases of debt. This expression is the difference between the present values of two different cash flows, each with its own risk: the present value of taxes for the unlevered company and the present value of taxes for the levered company. For perpetual debt, the value of tax shields is the debt times the tax rate. When the company is expected to repay the current debt without issuing new debt, the value of tax shields is the present value of the interest times the tax rate, discounted at the required return to debt.

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Bibliographic Info

Paper provided by IESE Business School in its series IESE Research Papers with number D/544.

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Length: 19 pages
Date of creation: 04 Mar 2004
Date of revision:
Handle: RePEc:ebg:iesewp:d-0544

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Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/
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Related research

Keywords: value tax shields; present value net increases debt; required return equity; leverage cost; unlevered beta; levered beta;

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  1. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
  2. Fernández , Pablo, 2002. "The value of tax shields is not equal to the present value of tax shields," IESE Research Papers D/459, IESE Business School.
  3. Lewellen, Wilbur G. & Emery, Douglas R., 1986. "Corporate Debt Management and the Value of the Firm," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(04), pages 415-426, December.
  4. Steven N. Kaplan & Richard S. Ruback, 1994. "The Valuation of Cash Flow Forecasts: An Empirical Analysis," NBER Working Papers 4724, National Bureau of Economic Research, Inc.
  5. Isik Inselbag & Howard Kaufold, 1997. "Two Dcf Approaches For Valuing Companies Under Alternative Financing Strategies (And How To Choose Between Them)," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(1), pages 114-122.
  6. Myers, Stewart C, 1974. "Interactions of Corporate Financing and Investment Decisions-Implications for Capital Budgeting," Journal of Finance, American Finance Association, vol. 29(1), pages 1-25, March.
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