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Value of tax shields and the risk of the net increase of debt, The. Year 2004

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  • Fernandez, Pablo

    () (IESE Business School)

Abstract

The value of tax shields depends on the nature of the stochastic process of the net increase of debt; it does not depend on the nature of the stochastic process of the free cash flow. The value of tax shields in a world with no leverage cost is the tax rate times the debt, plus the tax rate times the present value of the net increases of debt. This expression is the difference between the present values of two different cash flows, each with its own risk: the present value of taxes for the unlevered company and the present value of taxes for the levered company. For perpetual debt, the value of tax shields is the debt times the tax rate. When the company is expected to repay the current debt without issuing new debt, the value of tax shields is the present value of the interest times the tax rate, discounted at the required return to debt.

Suggested Citation

  • Fernandez, Pablo, 2004. "Value of tax shields and the risk of the net increase of debt, The. Year 2004," IESE Research Papers D/544, IESE Business School.
  • Handle: RePEc:ebg:iesewp:d-0544
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    File URL: http://www.iese.edu/research/pdfs/DI-0544-E.pdf
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    References listed on IDEAS

    as
    1. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
    2. 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.
    3. 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.
    4. 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 1059-1093, September.
    5. 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.
    6. 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.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    value tax shields; present value net increases debt; required return equity; leverage cost; unlevered beta; levered beta;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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