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Reply to "The value of tax shields is equal to the present value of tax shields"

  • Fernandez, Pablo

    ()

    (IESE Business School)

In a recent paper, Cooper and Nyborg (2004) argue that the results of Fernández (2004) are wrong because value-additivity is violated and because "Fernández paper comes from mixing the Miles-Ezzell leverage policy with the Miller-Modigliani leverage adjustment." Cooper and Nyborg's paper is thought-provoking and helps a lot in rethinking the value of tax shields. However, their conclusions are not correct because, as will be proven below, the main result of Fernández (2004) is correct for several situations. An evident error of Cooper and Nyborg (2004) is that their formulae (4), (6), (8) and (11), which they attribute to Miles and Ezzell (1980), correspond to Harris and Pringle (1985) and Ruback (2002). In addition, their formulae (3) and (5) are not general: they are valid only for perpetuities without growth. In this paper I also show that the value of tax shields depends only upon the nature of the stochastic process of the net increase of debt.

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Paper provided by IESE Business School in its series IESE Research Papers with number D/576.

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Length: 15 pages
Date of creation: 03 Nov 2004
Date of revision:
Handle: RePEc:ebg:iesewp:d-0576
Contact details of provider: Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/

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  1. Cooper, Ian A. & Nyborg, Kjell G., 2006. "The value of tax shields IS equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 81(1), pages 215-225, July.
  2. 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.
  3. Fernández , Pablo, 2002. "The value of tax shields is not equal to the present value of tax shields," IESE Research Papers D/459, IESE Business School.
  4. 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.
  5. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(03), pages 719-730, September.
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