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The valuation of tax shields induced by asset step-ups in corporate acquisitions

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  • Groh, Alexander P.

    ()
    (IESE Business School)

  • Henseleit, Christoph

    (Bain & Co. Munich)

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    Abstract

    We derive discount rates for depreciation and amortization tax shields resulting from asset step-ups in corporate mergers and acquisitions. By assigning all relevant sources of uncertainty for such kind of tax shields and by accounting for corporate debt it is shown that for APV valuations r*, a rate between the firm's cost of debt and the risk-free rate, is adequate to discount step-up induced depreciation benefits. When the benefits are valued on a standalone basis, the adequate discount rate is the after-tax weighted average of r*. Discount rates for these shields have been determined arbitrarily in empirical research on corporate acquisitions so far. However, they are found to be in line with the rates deduced in this paper.

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    Bibliographic Info

    Paper provided by IESE Business School in its series IESE Research Papers with number D/785.

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    Length: 27 pages
    Date of creation: 05 Mar 2009
    Date of revision:
    Handle: RePEc:ebg:iesewp:d-0785

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    Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
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    Keywords: Tax Shield; Step-up Depreciation; Valuation;

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    References

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    1. 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.
    2. Erickson, Merle & Wang, Shiing-wu, 2000. "The effect of transaction structure on price: Evidence from subsidiary sales," Journal of Accounting and Economics, Elsevier, vol. 30(1), pages 59-97, August.
    3. Schipper, Katherine & Smith, Abbie, 1991. "Effects of Management Buyouts on Corporate Interest and Depreciation Tax Deductions," Journal of Law and Economics, University of Chicago Press, vol. 34(2), pages 295-341, October.
    4. Alan J. Auerbach & David Reishus, 1986. "Taxes and the Merger Decision: An Empirical Analysis," NBER Working Papers 1855, National Bureau of Economic Research, Inc.
    5. Gordon A. Sick, 1990. "Tax-Adjusted Discount Rates," Management Science, INFORMS, vol. 36(12), pages 1432-1450, December.
    6. Isik Inselbag & Howard Kaufold, 1989. "How To Value Recapitalizations And Leveraged Buyouts," Journal of Applied Corporate Finance, Morgan Stanley, vol. 2(2), pages 87-96.
    7. Maydew, Edward L. & Schipper, Katherine & Vincent, Linda, 1999. "The impact of taxes on the choice of divestiture method," Journal of Accounting and Economics, Elsevier, vol. 28(2), pages 117-150, December.
    8. John R. Graham & Michael L. Lemmon, 1998. "Measuring Corporate Tax Rates And Tax Incentives: A New Approach," Journal of Applied Corporate Finance, Morgan Stanley, vol. 11(1), pages 54-65.
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