The value of tax shields IS equal to the present value of tax shields
In a recent paper, Fernandez (2004a) 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, it 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-Ezzell and Miller-Modigliani leverage policies.
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- Ian A. Cooper & Kjell G. Nyborg, 2008.
"Tax-Adjusted Discount Rates with Investor Taxes and Risky Debt,"
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IESE Research Papers
D/459, IESE Business School.
- Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July.
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9353, National Bureau of Economic Research, Inc.
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- Fernandez, Pablo, 2004. "Reply to "The value of tax shields is equal to the present value of tax shields"," IESE Research Papers D/576, IESE Business School.
- 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.
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- 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.
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