IDEAS home Printed from https://ideas.repec.org/a/inm/ormnsc/v36y1990i12p1432-1450.html
   My bibliography  Save this article

Tax-Adjusted Discount Rates

Author

Listed:
  • Gordon A. Sick

    (Faculty of Management, University of Calgary, Calgary, Alberta, T2N 1N4)

Abstract

This paper develops models for discount rates that are adjusted for the interest tax shields of an infra-marginal firm in a general tax equilibrium where there is cross-sectional variation in corporate tax rates. Under the assumption that the firm optimally maintains a predetermined debt ratio, a tax-adjusted riskless discount rate model is given for valuing certainty-equivalents and a tax-and-risk-adjusted discount rate model is given for valuing expected cash flows. For the latter case, the asset, equity, debt and tax-shield betas are derived and a weighted average cost of capital interpretation is given. The tax-adjusted CAPM/APT security market lines for expected returns in stock and bond markets both have the same slope but different intercepts. A formula is also provided for the present value of the interest tax shield when the firm optimally maintains a predetermined debt level. The analysis here also differs from the existing literature in the following respects: It allows for cross-sectional variation in corporate tax rates and personal tax rates. It shows that the market values of risky and riskless interest tax shields differ only to the extent that tax laws provide for nonlinear taxation of gains and losses. It also shows that interest tax shields should be discounted at a tax-adjusted discount rate that reflects the fact that they accrue to equity investors, rather than debt investors. Continuous-time simplifications of the formulas in this paper and the previous literature are also given.

Suggested Citation

  • Gordon A. Sick, 1990. "Tax-Adjusted Discount Rates," Management Science, INFORMS, vol. 36(12), pages 1432-1450, December.
  • Handle: RePEc:inm:ormnsc:v:36:y:1990:i:12:p:1432-1450
    DOI: 10.1287/mnsc.36.12.1432
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1287/mnsc.36.12.1432
    Download Restriction: no

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Benninga, Simon & Sarig, Oded, 2003. "Risk, returns, and values in the presence of differential taxation," Journal of Banking & Finance, Elsevier, vol. 27(6), pages 1123-1138, June.
    2. Krause, Marko & Lahmann, Alexander, 2017. "Valuation effects of taxes on debt cancellation," The Quarterly Review of Economics and Finance, Elsevier, vol. 65(C), pages 346-354.
    3. Lund, Diderik, 2006. "Taxation and systematic risk under decreasing returns to scale," Working Papers 02-2003, Copenhagen Business School, Department of Economics.
    4. Fieten, Paul & Kruschwitz, Lutz & Laitenberger, Jorg & Loffler, Andreas & Tham, Joseph & Velez-Pareja, Ignacio & Wonder, Nicholas, 2005. "Comment on "The value of tax shields is NOT equal to the present value of tax shields"," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(1), pages 184-187, February.
    5. Molnár, Peter & Nyborg, Kjell G, 2011. "Tax-Adjusted Discount Rates: A General Formula under Constant Leverage Ratios," CEPR Discussion Papers 8330, C.E.P.R. Discussion Papers.
    6. Ian A. Cooper & Kjell G. Nyborg, 2008. "Tax‐Adjusted Discount Rates with Investor Taxes and Risky Debt," Financial Management, Financial Management Association International, vol. 37(2), pages 365-379, June.
    7. James A. Miles & John R. Ezzell & Premal P. Vora, 2018. "Revisiting the standard lease valuation model: new results," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 42(2), pages 409-420, April.
    8. Fernandez, Pablo, 2004. "Comments on "A reconsideration of tax shield valuation" by Enrique R. Arzac and Lawrence R. Glosten," IESE Research Papers D/578, IESE Business School.
    9. Bianconi, Marcelo, 1995. "Fiscal policy in a simple two-country dynamic model," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 395-419.
    10. Mike Dempsey & Graham Partington, 2008. "Cost of capital equations under the Australian imputation tax system," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 48(3), pages 439-460, September.
    11. Fernandez, Pablo, 2005. "Reply to "Comment on the value of tax shields is NOT equal to the present value of tax shields"," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(1), pages 188-192, February.
    12. Sven Arnold & Alexander Lahmann & Bernhard Schwetzler, 2018. "Discontinuous financing based on market values and the value of tax shields," Business Research, Springer;German Academic Association for Business Research, vol. 11(1), pages 149-171, February.
    13. Gordon Sick & Andrea Gamba, 2010. "Some Important Issues Involving Real Options: An Overview," Multinational Finance Journal, Multinational Finance Journal, vol. 14(1-2), pages 73-123, March-Jun.
    14. Groh, Alexander P. & Henseleit, Christoph, 2009. "The valuation of tax shields induced by asset step-ups in corporate acquisitions," IESE Research Papers D/785, IESE Business School.
    15. Lund, Diderik, 2005. "An analytical model of required returns to equity under taxation with imperfect loss offset," Memorandum 13/2005, Oslo University, Department of Economics.
    16. Peter Molnár & Kjell G. Nyborg, 2013. "Tax†adjusted Discount Rates: a General Formula under Constant Leverage Ratios," European Financial Management, European Financial Management Association, vol. 19(3), pages 419-428, June.
    17. Marko Volker Krause & Alexander Lahmann, 2016. "Reconsidering the appropriate discount rate for tax shield valuation," Journal of Business Economics, Springer, vol. 86(5), pages 477-512, July.
    18. Michael Dempsey, 2019. "Discounting methods and personal taxes," European Financial Management, European Financial Management Association, vol. 25(2), pages 310-324, March.
    19. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:36:y:1990:i:12:p:1432-1450. 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: (Matthew Walls). General contact details of provider: http://edirc.repec.org/data/inforea.html .

    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.

    We have no references for this item. You can help adding them by using 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.