Return to Basics: Are You Properly Calculating Tax Shields?

Velez-Pareja, Ignacio

doi:10.2139/ssrn.1306043

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Return to Basics: Are You Properly Calculating Tax Shields?

Análisis Financiero, n.º 122. 2013. Pgs.: 6-17

15 Pages Posted: 25 Nov 2008 Last revised: 18 Mar 2014

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: July 15, 2009

Abstract

Everybody uses tax shields when calculating the Weighted Average Cost of Capital (WACC). The textbook formula includes the tax shield with the (1-T) factor affecting the contribution of debt to the WACC. Tax shields are a strange mix of accounting and accrual related to WACC that relies on market values. In this short work we show some limitations and care that have to be taken into account when using tax shields. We illustrate these ideas with simple examples.

Keywords: Weighted Average Cost of Capital, WACC, firm valuation, capital budgeting, tax shields, tax savings

JEL Classification: G12, D61, G31, H43

Suggested Citation: Suggested Citation

Velez-Pareja, Ignacio, Return to Basics: Are You Properly Calculating Tax Shields? (July 15, 2009). Análisis Financiero, n.º 122. 2013. Pgs.: 6-17, Available at SSRN: https://ssrn.com/abstract=1306043 or http://dx.doi.org/10.2139/ssrn.1306043