Debt Policy, Corporate Taxes, and Discount Rates
UCLA Finance Working Paper No. 14-02
34 Pages Posted: 13 Jun 2003
Date Written: November 7, 2002
This paper studies the valuation of assets with debt tax shields when debt policy is a general time-dependent function of the asset's unlevered cash flows, value, and history. In a continuous-time setting, it shows that the value of a project's debt tax shield satisfies a partial differential equation, which simplifies to an easily solved ordinary differential equation for most plausible debt policies. A large class of cases exhibits closed-form solutions for the value of a levered asset, the value of its tax shield, and the appropriate tax-adjusted cost of capital for discounting unlevered cash flows.
Keywords: debt policy, corporate taxes, discount rates, weighted cost of capital
JEL Classification: G1, G3, H2
Suggested Citation: Suggested Citation