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Valuing companies with a fixed book-value leverage ratio

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  • Fernandez, Pablo

    (IESE Business School)

Abstract

We develop valuation formulae for a company that maintains a fixed book-value leverage ratio and claim that it is more realistic than to assume, as Miles-Ezzell (1980) do, a fixed market-value leverage ratio. The value of tax shields depends only on the present value 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 also show that the appropriate discount rates for the equity cash flows and for the expected value of the equity are different.

Suggested Citation

  • Fernandez, Pablo, 2005. "Valuing companies with a fixed book-value leverage ratio," IESE Research Papers D/614, IESE Business School.
    • Handle: RePEc:ebg:iesewp:d-0614
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    File URL: http://www.iese.edu/research/pdfs/DI-0614-E.pdf
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    References listed on IDEAS

    as
    1. Cooper, Ian A. & Nyborg, Kjell G., 2006. "The value of tax shields IS equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 81(1), pages 215-225, July.
    2. Enrique R. Arzac & Lawrence R. Glosten, 2005. "A Reconsideration of Tax Shield Valuation," European Financial Management, European Financial Management Association, vol. 11(4), pages 453-461, September.
    3. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
    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.
    5. 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.
    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.
    7. 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(3), pages 719-730, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

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

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