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The Value of Tax Shields is the Difference of Two Present Values with Different Risk

13 Pages Posted: 17 Dec 2001  

Pablo Fernandez

University of Navarra - IESE Business School

Date Written: December 15, 2001

Abstract

We show that the value of tax shields is the difference between the present values of two different cash flows with their own risk: the present value of taxes for the unlevered company and the present value of taxes for the levered company. For perpetuities without costs of leverage, the value of tax shields is equal to the tax rate times the value of debt. For any company, we claim that the value of the tax shield in a world with no leverage cost is the present value of the debt (D) times the tax rate (T) times the required return to the unlevered equity (Ku), discounted at the unlevered cost of equity (Ku): VTS = PV[Ku; D T Ku]. Please note that it does not mean that the appropriate discount for the tax shields is the unlevered cost of equity. We discount D T Ku, which is not the tax shield. This expression arises as the difference of two present values each with different risk.

Keywords: Value of tax shields; Tax shields, APV; Costs of leverage

JEL Classification: G12, G31, M21

Suggested Citation

Fernandez, Pablo, The Value of Tax Shields is the Difference of Two Present Values with Different Risk (December 15, 2001). Available at SSRN: https://ssrn.com/abstract=294279 or http://dx.doi.org/10.2139/ssrn.294279

Pablo Fernandez (Contact Author)

University of Navarra - IESE Business School ( email )

Camino del Cerro del Aguila 3
28023 Madrid
Spain
+34 91 357 0809 (Phone)
+34 91 357 2913 (Fax)

HOME PAGE: http://web.iese.edu/PabloFernandez/

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