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The value of tax shields depends only on the net increases of debt

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  • Fernandez, Pablo

    () (IESE Business School)

Abstract

The value of tax shields depends only on the nature of the stochastic process of the net increases of debt. The value of tax shields in a world with no leverage cost is the tax rate times the current debt plus the present value of the net increases of debt. By applying this formula to specific situations, we show that Modigliani-Miller (1963) should be used when the company has a preset amount of debt, Fernández (2004) when the company maintains a fixed book-value leverage ratio, and Miles-Ezzell (1980) when the company maintains a fixed market-value leverage ratio.

Suggested Citation

  • Fernandez, Pablo, 2005. "The value of tax shields depends only on the net increases of debt," IESE Research Papers D/613, IESE Business School.
  • Handle: RePEc:ebg:iesewp:d-0613
    as

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    File URL: http://www.iese.edu/research/pdfs/DI-0613-E.pdf
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    References listed on IDEAS

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

    More about this item

    Keywords

    Value of tax shields; present value of the net increases of debt; required return to equity;

    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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