IDEAS home Printed from https://ideas.repec.org/p/col/000463/003578.html
   My bibliography  Save this paper

The Correct Discount Rate for the Tax Shield: The N-period Case

Author

Listed:
  • Joseph Tham

    ()

  • Ignacio Velez-Pareja

    ()

Abstract

Using no-arbitrage arguments in an M & M world, we show that in the N-period case, the appropriate discount rate for the tax shield is rho, the return to unlevered equity. We make no assumption about the appropriate discount rate for the tax shield. Instead, the appropriate discount rate for the tax shield is deduced from the no-arbitrage arguments. Furthermore, it is shown that the appropriate discount rate for the tax shield does not depend on whether the value of the debt is a fixed amount or is a fixed proportion of the levered value of the firm. The analysis begins at the end of the penultimate period N-1. First, we assume that the value of the levered cash flow is higher than the sum of the value of the unlevered cash flow and the value of the tax shield. It is shown that the inequality cannot hold because arbitrage opportunities exist. The equality only holds if the discount rate for the tax shield is rho, the return to unlevered equity. Second, we assume that the value of the levered cash flow is lower than the sum of the value of the unlevered cash flow and the value of the tax shield. Again, it is shown that the inequality cannot hold because arbitrage opportunities exist. The equality only holds if the discount rate for the tax shield is rho, the return to unlevered equity. Using an iterative process, the argument can be extended period by period backwards to period zero. In conclusion, in the N-period case, the appropriate discount rate for the tax shield is rho, the return to unlevered equity.

Suggested Citation

  • Joseph Tham & Ignacio Velez-Pareja, 2000. "The Correct Discount Rate for the Tax Shield: The N-period Case," Proyecciones Financieras y Valoración 003578, Master Consultores.
  • Handle: RePEc:col:000463:003578
    as

    Download full text from publisher

    File URL: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=267962
    Download Restriction: no

    Citations

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


    Cited by:

    1. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    2. Fernandez, Pablo, 2003. "Equivalence of ten different methods for valuing companies by cash flow discounting," IESE Research Papers D/524, IESE Business School.
    3. 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.

    More about this item

    Keywords

    Value of Tax Shield;

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis

    Statistics

    Access and download statistics

    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:col:000463:003578. 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: (Ignacio Velez). General contact details of provider: .

    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.