Cost of Capital and Valuation in the Public and Private Sectors: Tax, Risk and Debt Capacity

25 Pages Posted: 27 May 2020

See all articles by Richard A. Brealey

Richard A. Brealey

London Business School

Ian A. Cooper

London Business School

Michel A. Habib

University of Zurich

Date Written: January/February 2020

Abstract

Cost of capital and valuation differ in the private and public sectors, because taxes are a cost to the private sector but are only a transfer to the public sector. We show how to transform the after‐tax private sector cost of capital into its pre‐tax equivalent, for comparison with the public sector cost of capital. We establish the existence of a tax induced wedge between these two costs of capital. The wedge introduces a preference on the part of the private sector for assets with rapid tax depreciation, high debt capacity and low risk. We show that, in circumstances where an asset has identical public and private sector valuation in the absence of taxes, the tax induced difference in valuation is identical to the change in government tax receipts that results from having the asset owned by the private rather than the public sector. We provide some examples of distortions that result from failure to adjust for changes in tax revenues, and show how to effect such adjustment.

Keywords: cost of capital, debt capacity, depreciation, outsourcing, private sector, privatization, public sector, regulation, risk, tax, valuation

JEL Classification: G18

Suggested Citation

Brealey, Richard A. and Cooper, Ian Anthony and Habib, Michel A., Cost of Capital and Valuation in the Public and Private Sectors: Tax, Risk and Debt Capacity (January/February 2020). Journal of Business Finance & Accounting, Vol. 47, Issue 1-2, pp. 163-187, 2020, Available at SSRN: https://ssrn.com/abstract=3605620 or http://dx.doi.org/10.1111/jbfa.12413

Richard A. Brealey (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 207 262 5050 Ext. 3462 (Phone)
+44 207 724 3317 (Fax)

Ian Anthony Cooper

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 171 262 5050 (Phone)

Michel A. Habib

University of Zurich

Rämistrasse 71
Zürich, CH-8006
Switzerland

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
1
Abstract Views
79
PlumX Metrics