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Debt Policy, Corporate Taxes, and Discount Rates

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Mark Grinblatt
Jun Liu

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Abstract

This paper studies the valuation of assets with debt tax shields when debt policy is a general time-dependent function of the asset's unlevered cash flows, value, and history. In a continuous-time setting, it shows that the value of a project's debt tax shield satisfies a partial differential equation, which simplifies to an easily solved ordinary differential equation for most plausible debt policies. A large class of cases exhibits closed-form solutions for the value of a levered asset, the value of its tax shield, and the appropriate tax-adjusted cost of capital for discounting unlevered cash flows.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9353.

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Date of creation: Nov 2002
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Handle: RePEc:nbr:nberwo:9353

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G0 - Financial Economics - - General
G1 - Financial Economics - - General Financial Markets

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Ross, Stephen A, 1978. "A Simple Approach to the Valuation of Risky Streams," Journal of Business, University of Chicago Press, vol. 51(3), pages 453-75, July. [Downloadable!] (restricted)
  2. Hamada, Robert S, 1972. "The Effect of the Firm's Capital Structure on the Systematic Risk of Common Stocks," Journal of Finance, American Finance Association, vol. 27(2), pages 435-52, May. [Downloadable!] (restricted)
  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. Richard C. Green & Burton Hollifield, . "The Personal-Tax Advantages of Equity," GSIA Working Papers 2000-E10, Carnegie Mellon University, Tepper School of Business. [Downloadable!]
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  5. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-52, September. [Downloadable!] (restricted)
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  6. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May. [Downloadable!] (restricted)
  7. Deen Kemsley & Doron Nissim, 2002. "Valuation of the Debt Tax Shield," Journal of Finance, American Finance Association, vol. 57(5), pages 2045-2073, October. [Downloadable!] (restricted)
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  1. 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. [Downloadable!] (restricted)
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