Cash Stream Valuation in the Face of Transaction Costs and Taxes

Abstract:     
The usual notion of every future cash stream having a net present value determined from a single term structure breaks down when transaction costs are taken into account, especially the sizable costs associated with short-borrowing. the difficulties are compounded by taxes, which can lead to paradoxes of disequilibrium if elementary NPV is assumed to be a rational basis for decision making. This paper systematically develops a theory of valuation which overcomes these shortcomings by accepting the multiplicity of no-arbitrage term structures that may be present for each tax class of investors, and uses the entire set of them to impute both a long price and a short price for every cash stream, regardless of the sign of the future payments. the valuation operators giving these prices are nonlinear but readily calculated from linear programming formulas.

Number of Pages in PDF File: 24

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