Market Valuation Model Under Differential Taxes, Inflation, Recurring Investments and Flotation Costs

The extent literature on valuation identifies several important variables affecting the value of a firm. These include, corporate and personal taxes, reinvestments, leverage, dividend policy, and inflation. But, most of the papers have focussed only on a small number of these variables at a time and constructed comparatively simple valuation models designed to answer relatively limited questions in valuation theory. However, the fact remains that the above variables interact in quite complex ways, and it is necessary to have a comprehensive valuation model which captures most of the complexities and subtleties of real world corporate finance. This paper is an attempt at developing such a model. The model is capable of supporting both the Gordon and MM type assumptions about the investment policy of the firm. It allows for personal taxes with differential tax rates for dividends, interest and capital gains. The model also takes into account flotation costs on debt and equity. Further, unlike other models which define capital gains as the increase in the book value which in turn equals retained earnings, this model interprets capital gains as the increase in the market value of the share. Finally, the model is modified to take into account Lintner’s concern about inflation eroding the real value of the firm’s assets, particularly, net monetary working capital. The paper also numerically depicts the impact of manifold taxes on valuation and the complex interactions of different variables in influencing the firm value.