The value of tax shields is NOT equal to the present value of tax shields
We show that the value of tax shields is the difference between the present values of two different cash flows with their own risk: the present value of taxes for the unlevered company and the present value of taxes for the levered company. For perpetuities without costs of leverage, the value of tax shields is equal to the tax rate times the value of debt. Since the existence of leverage costs is independent of taxes, the value of tax shields when there are no taxes should be negative. We later on look at the case of constant growth and derive similar implications. We then identify 9 valuation theories proposed in the literature to estimate the present value of tax shields and show that only one valuation method is consistent when we look at the case of constant growth and no leverage costs. Three theories provide consistent valuations once leverage costs and growth are allowed for. For constant growth companies, we claim that the value of the tax shield in a world with no leverage cost is the present value of the debt (D) times the tax rate (T) times the required return to the unlevered equity (Ku), discounted at the unlevered cost of equity (Ku): VTS = PV[Ku; D T Ku]. Please note that this does not mean that the appropriate discount for the tax shields is the unlevered cost of equity. We discount D T Ku, which is higher than the shield. This expression arises as the difference of two present values, each with different risk
(This abstract was borrowed from another version of this item.)
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
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.:
- Joseph Tham & Ignacio Velez-Pareja, 2000. "The Correct Discount Rate for the Tax Shield: The N-period Case," PROYECCIONES FINANCIERAS Y VALORACION 003578, MASTER CONSULTORES.
- 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.
- Robert A. Taggart & Jr., 1991. "Consistent valuation and Cost of Capital Expressions With Corporate and Personal Taxes," Financial Management, Financial Management Association, vol. 20(3), Fall.
- Miles, James A & Ezzell, John R, 1985. " Reformulating Tax Shield Valuation: A Note," Journal of Finance, American Finance Association, vol. 40(5), pages 1485-92, December.
- Steven N. Kaplan & Richard S. Ruback, 1994.
"The Valuation of Cash Flow Forecasts: An Empirical Analysis,"
NBER Working Papers
4724, National Bureau of Economic Research, Inc.
- Kaplan, Steven N & Ruback, Richard S, 1995. " The Valuation of Cash Flow Forecasts: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 50(4), pages 1059-93, September.
- Lewellen, Wilbur G. & Emery, Douglas R., 1986. "Corporate Debt Management and the Value of the Firm," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(04), pages 415-426, December.
- Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
- Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
- 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.
- 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(03), pages 719-730, September.
When requesting a correction, please mention this item's handle: RePEc:eee:jfinec:v:73:y:2004:i:1:p:145-165. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Shamier, Wendy)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.