Tax-Adjusted Discount Rates with Investor Taxes and Risky Debt

Financial Management, Summer 2008

Posted: 1 Oct 2008

See all articles by Ian A. Cooper

Ian A. Cooper

London Business School

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Multiple version iconThere are 3 versions of this paper

Date Written: September, 30 2008

Abstract

This paper derives tax-adjusted discount rate formulas with a constant proportion leverage policy, investor taxes, and risky debt. The result depends on an assumption about the treatment of tax losses in default. We identify the assumption that justifies the textbook approach of discounting interest tax shields at the cost of debt. We contrast this with an alternative assumption that leads to the Sick (1990) result that these should be discounted at the riskless rate. These two approaches represent polar cases. Each generates its results by using a different simplifying assumption, and we explain what determines the correct treatment in practice. We also discuss implementation of the valuation procedure using the CAPM.

Keywords: Capital structure, value of tax shields, risky debt, cost of capital, WACC

JEL Classification: G12, G31, G32, M21

Suggested Citation

Cooper, Ian Anthony and Nyborg, Kjell G., Tax-Adjusted Discount Rates with Investor Taxes and Risky Debt (September, 30 2008). Financial Management, Summer 2008, Available at SSRN: https://ssrn.com/abstract=1275758

Ian Anthony Cooper (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 171 262 5050 (Phone)

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 (0)44 634 2980 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Here is the Coronavirus
related research on SSRN

Paper statistics

Abstract Views
914
PlumX Metrics