Cooper, Ian A. () (London Business School) Nyborg, Kjell G. () (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
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Fernandez (2004b) argues that the present value effect of the tax saving on debt cannot be calculated as simply the present value of the tax shields associated with interest. This contradicts standard results in the literature. It implies that, even though the capital market is complete, value-additivity is violated. As a consequence, adjusted present value formulae of a standard sort cannot be used. Also, Fernandez’s argument implies that the value of the tax saving differs from conventional estimates by a considerable amount. We reconcile Fernandez’s results with standard valuation formulae for the tax saving from debt. We show that, as one would expect, the value of the debt tax saving is the present value of the tax savings from interest. The apparent violation of value-additivity in the Fernandez paper comes from mixing the Miles and Ezzell and Miller and Modigliani leverage policies.
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Paper provided by Department of Finance and Management Science, Norwegian School of Economics and Business Administration in its series Discussion Papers with number
2005/14.
Length: 16 pages Date of creation: 22 Dec 2005 Date of revision: Handle: RePEc:hhs:nhhfms:2005_014
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