A Reconsideration of Tax Shield Valuation

11 Pages Posted: 28 May 2004

See all articles by Enrique R. Arzac

Enrique R. Arzac

Columbia Business School - Finance and Economics

Lawrence R. Glosten

Columbia Business School - Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: August 2, 2004

Abstract

A quarter-century ago, Miles and Ezzell (1980) solved the valuation problem of a firm that follows a constant leverage ratio L = D/S. However, to this day, the proper discounting of free cash flows and the computation of WACC are often misunderstood by scholars and practitioners alike. For example, it is common for textbooks and fairness opinions to discount free cash flows at WACC with beta input Bs = [1+(1-t)L]Bu, although the latter is not consistent with the assumption of constant leverage. This confusion extends to the valuation of tax shields and the proper implementation of adjusted present value procedures. In this paper, we derive a general result on the value of tax shields, obtain the correct value of tax shields for perpetuities, and state the correct valuation formulas for arbitrary cash flows under a constant leverage financial policy.

Keywords: Tax shield valuation, WACC, APV, cost of capital, leveraged beta

JEL Classification: G13, G30, G31, G32, G33

Suggested Citation

Arzac, Enrique R. and Glosten, Lawrence R., A Reconsideration of Tax Shield Valuation (August 2, 2004). Available at SSRN: https://ssrn.com/abstract=492603 or http://dx.doi.org/10.2139/ssrn.492603

Enrique R. Arzac (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Lawrence R. Glosten

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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