Consistent Valuation in the Two-Period Case: A Pedagogical Note (Dinh Gia Thong Nhat Trong Truong Hop Hai Giai Doan: Bai Viet Giang Day) (Vietnamese Version)

Abstract

It is widely accepted that the correct discount rate for the tax shield depends on whether the value of the debt is a fixed amount or is a proportion of the value of the firm.

In this pedagogical note, using a simple two period numerical example, I assume a fixed amount of debt and demonstrate that if the cost of debt is used to discount the tax shield to determine the value of the levered firm, arbitrage opportunities exist.

I propose that it is always correct to use the return on unlevered equity, to discount the tax shield. Consequently, the correct discount rate for the tax shield does not depend on whether the value of the debt is a fixed amount or is a proportion of the value of the firm. It is not difficult to extend the analysis to the multiperiod case. Happily, all the inconsistencies are resolved if the return on unlevered equity, is used to discount the tax shield.

Note: Downloadable document is in Vietnamese. The English version is available to download at: http://ssrn.com/abstract=234997

Keywords: capital budgeting

JEL Classification: G31