Risky Tax Shields: An Exploratory Study

Cuadernos de Administración, Vol. 23, No. 41, pp. 213-235, December, 2010

24 Pages Posted: 9 Nov 2010 Last revised: 5 Aug 2013

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: November 8, 2010

Abstract

This article (1) identifies three sources of risk for tax shields (TS): Two of them are associated with debt risk and one is associated with operating risk. (2) A set of conditions for defining risky debt associated with cash flow, not with earnings, is presented. (3) It further shows that realization of TS for finite cash flows in a period of time t is correlated with Earnings before Interest and Taxes (EBIT) plus Other Income (EBITO), not with interest expenses at time t.

With the results of a Montecarlo Simulation the behavior of TS, Cash Flow to Debt and EBITO are examined.

In conclusion, the article suggests that it is not reasonable to define the risk of TS as measured by a single discount rate, but rather as a mix of debt risk and operating risk.

Keywords: Weighted Average Cost of Capital, WACC, Firm Valuation, Tax Shields, Cash Flows, Monte Carlo Simulation, Discount Rate for Tax Shields, Risky Debt, Risky Tax Shields

JEL Classification: M21, M40, M46, M41, G12, G31, J33

Suggested Citation

Velez-Pareja, Ignacio, Risky Tax Shields: An Exploratory Study (November 8, 2010). Cuadernos de Administración, Vol. 23, No. 41, pp. 213-235, December, 2010. Available at SSRN: https://ssrn.com/abstract=1705771

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

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