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The value of tax shields with a fixed book-value leverage ratio

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  • Fernandez, Pablo

    ()
    (IESE Business School)

Abstract

The value of tax shields depends only on the nature of the stochastic process of the net increases of debt. The value of tax shields in a world with no leverage cost is the tax rate times the current debt plus the present value of the net increases of debt. We develop valuation formulae for a company that maintains a fixed book-value leverage ratio and show that it is more realistic than to assume, as Miles-Ezzell (1980) do, a fixed market-value leverage ratio. We also show that Miles-Ezzell assume that the increase of debt is proportional to the increase of the free cash flows.

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Bibliographic Info

Paper provided by IESE Business School in its series IESE Research Papers with number D/612.

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Length: 30 pages
Date of creation: 15 Oct 2005
Date of revision:
Handle: RePEc:ebg:iesewp:d-0612

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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 of tax shields; present value of the net increases of debt; required return to equity;

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  1. 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.
  2. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
  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. 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.
  5. 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.
  6. Fieten, Paul & Kruschwitz, Lutz & Laitenberger, Jorg & Loffler, Andreas & Tham, Joseph & Velez-Pareja, Ignacio & Wonder, Nicholas, 2005. "Comment on "The value of tax shields is NOT equal to the present value of tax shields"," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(1), pages 184-187, February.
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