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Comments on "A reconsideration of tax shield valuation" by Enrique R. Arzac and Lawrence R. Glosten

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  • Fernandez, Pablo

    ()
    (IESE Business School)

Abstract

While Arzac and Glosten (2005) affirm that "the value of tax shields depends upon the nature of the equity stochastic process, which, in turn, depends upon the free cash flow process," I prove that the value of tax shields depends only upon the nature of the stochastic process of the net increase of debt. Arzac and Glosten (2005) formulate the constant leverage ratio assumption as Dt = L•Et. The assumption of Fernández (2004) is E{Dt}= L•E{Et}, where E{•} is the expected value operator, D the value of debt, E the equity value, and L a constant. The Arzac and Glosten (2005) assumption requires continuous debt rebalancing, while mine does not. Under both financial policies, the expected leverage ratio is constant, but the Arzac and Glosten (2005) assumption is too extreme.

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Bibliographic Info

Paper provided by IESE Business School in its series IESE Research Papers with number D/578.

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Length: 8 pages
Date of creation: 03 Nov 2004
Date of revision:
Handle: RePEc:ebg:iesewp:d-0578

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Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/
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Keywords: Value of tax shields; required return to equity; cost of capital; net increase of debt;

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  1. Gordon A. Sick, 1990. "Tax-Adjusted Discount Rates," Management Science, INFORMS, vol. 36(12), pages 1432-1450, December.
  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. 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.
  4. 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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