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Reply to "The value of tax shields is equal to the present value of tax shields"

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Author Info
Fernandez, Pablo () (IESE Business School)

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Abstract

In a recent paper, Cooper and Nyborg (2004) argue that the results of Fernández (2004) are wrong because value-additivity is violated and because "Fernández paper comes from mixing the Miles-Ezzell leverage policy with the Miller-Modigliani leverage adjustment." Cooper and Nyborg's paper is thought-provoking and helps a lot in rethinking the value of tax shields. However, their conclusions are not correct because, as will be proven below, the main result of Fernández (2004) is correct for several situations. An evident error of Cooper and Nyborg (2004) is that their formulae (4), (6), (8) and (11), which they attribute to Miles and Ezzell (1980), correspond to Harris and Pringle (1985) and Ruback (2002). In addition, their formulae (3) and (5) are not general: they are valid only for perpetuities without growth. In this paper I also show that the value of tax shields depends only upon the nature of the stochastic process of the net increase of debt.

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Paper provided by IESE Business School in its series IESE Research Papers with number D/576.

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Length: 15 pages
Date of creation: 03 Nov 2004
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Handle: RePEc:ebg:iesewp:d-0576

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Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
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Related research
Keywords: Value of tax shields; Present value of the net increases of debt; unlevered beta; levered beta; leverage cost;

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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  1. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(03), pages 719-730, September. [Downloadable!]
  2. Cooper, Ian A. & Nyborg, Kjell G., 2005. "The value of tax shields IS equal to the present value of tax shields," Discussion Papers 2005/14, Department of Finance and Management Science, Norwegian School of Economics and Business Administration. [Downloadable!]
    Other versions:
  3. Robert A. Taggart & Jr., 1991. "Consistent valuation and Cost of Capital Expressions With Corporate and Personal Taxes," Financial Management, Financial Management Association, vol. 20(3), Fall.
  4. Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July. [Downloadable!] (restricted)
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