On the Risk-Neutral Value of Debt Tax Shields

Posted: 11 Aug 2011 Last revised: 17 Oct 2011

See all articles by Massimiliano Barbi

Massimiliano Barbi

University of Bologna - Department of Management

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Date Written: August 9, 2011

Abstract

The recent interest in the valuation of the benefits from debt financing arises from the disagreement in the financial literature about the meaning of “value of tax shields.” Although it is accepted that the tax deductibility of interest increases the value of the firm, the correct valuation of this extra-value is controversial. We adopt a risk-neutral approach to derive a general formula for the value of tax shields. This framework clearly shows that this value equals the summation of the discounted future tax savings. Once we specify a leverage policy and a cash flow dynamics some well-known formulas are obtained.

Keywords: Value of Tax Shields, Leverage Policy, WACC, APV

JEL Classification: G12, G31, G32

Suggested Citation

Barbi, Massimiliano, On the Risk-Neutral Value of Debt Tax Shields (August 9, 2011). Applied Financial Economics, Vol. 22, pp. 251-258, 2012. Available at SSRN: https://ssrn.com/abstract=1907992

Massimiliano Barbi (Contact Author)

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