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How Taxes on Firms Reduce the Risk of After-Tax Cash Flows

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  • Diderik Lund

Abstract

Most firms use one discount rate applied to expected net after-tax cash flows. The need to adjust for differences in risk, other than leverage, is commonly neglected. There can be substantial effects of taxation on after-tax risk when there are depreciation deductions. Among the few studies of these effects, even fewer identify all effects correctly. When marginal investment is taxed together with inframarginal, the marginal beta for the Capital Asset Pricing Model differs from the average. The problems identified here imply that currently suggested tax reforms may fail. Tax neutrality results rely on firms correctly discounting for risk, in particular the risk of tax deductions.

Suggested Citation

  • Diderik Lund, 2014. "How Taxes on Firms Reduce the Risk of After-Tax Cash Flows," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 70(4), pages 567-598, December.
  • Handle: RePEc:mhr:finarc:urn:sici:0015-2218(201412)70:4_567:htofrt_2.0.tx_2-e
    DOI: 10.1628/001522108X685492
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    Citations

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    Cited by:

    1. Hebous, Shafik & Ruf, Martin, 2017. "Evaluating the effects of ACE systems on multinational debt financing and investment," Journal of Public Economics, Elsevier, vol. 156(C), pages 131-149.
    2. Shafik Hebous & Alexander Klemm, 2020. "A destination-based allowance for corporate equity," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 27(3), pages 753-777, June.
    3. Babak Jafarizadeh & Reidar B. Bratvold, 2019. "Exploration economics: taking opportunities and the risk of double-counting risk," Mineral Economics, Springer;Raw Materials Group (RMG);Luleå University of Technology, vol. 32(3), pages 323-335, November.
    4. Berg, Magnus & Bøhren, Øyvind & Vassnes, Erik, 2018. "Modeling the response to exogenous shocks: The capital uplift rate in petroleum taxation," Energy Economics, Elsevier, vol. 69(C), pages 442-455.
    5. Lund, Diderik, 2018. "Increasing resource rent taxation when the corporate income tax is reduced?," Memorandum 3/2018, Oslo University, Department of Economics.

    More about this item

    Keywords

    cost of capital; WACC; loss offset; tax shields; options;

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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