The value of tax shields IS equal to the present value of tax shields
Fernandez (2004b) argues that the present value effect of the tax saving on debt cannot be calculated as simply the present value of the tax shields associated with interest. This contradicts standard results in the literature. It implies that, even though the capital market is complete, value-additivity is violated. As a consequence, adjusted present value formulae of a standard sort cannot be used. Also, Fernandez’s argument implies that the value of the tax saving differs from conventional estimates by a considerable amount. We reconcile Fernandez’s results with standard valuation formulae for the tax saving from debt. We show that, as one would expect, the value of the debt tax saving is the present value of the tax savings from interest. The apparent violation of value-additivity in the Fernandez paper comes from mixing the Miles and Ezzell and Miller and Modigliani leverage policies.
|Date of creation:||22 Dec 2005|
|Date of revision:|
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6646, C.E.P.R. Discussion Papers.
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- Cooper, Ian A. & Nyborg, Kjell G., 2005. "Tax-adjusted discount rates with investor taxes and risky debt," Discussion Papers 2005/15, Department of Business and Management Science, Norwegian School of Economics, revised 20 Sep 2007.
- Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
- Fernandez, Pablo, 2004. "Reply to "The value of tax shields is equal to the present value of tax shields"," IESE Research Papers D/576, IESE Business School.
- Enrique R. Arzac & Lawrence R. Glosten, 2005. "A Reconsideration of Tax Shield Valuation," European Financial Management, European Financial Management Association, vol. 11(4), pages 453-461.
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