Adjusting Discount Rates in the Presence of a Simple Tax System (Die Arbitragefreie Adjustierung von Diskontierungssätzen bei einfacher Gewinnsteuer)
Schmalenbachs Zeitschrift für betriebswirtschaftliche Forschung, Vol. 58, No. 6, pp. 771-806, September 2006
41 Pages Posted: 17 May 2004 Last revised: 7 Aug 2009
Date Written: December 20, 2006
For investment projects with finite horizon and deterministic leverage the idea of weighted average cost of capital (wacc) was introduced 1980 by Miles/Ezzell under restrictive assumptions. In this paper we deal with the wacc idea in the context of arbitrage-free capital markets by relaxing the assumptions of Miles/Ezzell. In particular we allow for general cash flow structures and risky debt. Following Miles/Ezzell we restrict ourselves to the situation of a linear tax on corporate level and debt financing according to a deterministic leverage. Under these conditions we derive an arbitrage-free relation that links the discount rates of a particular cash flow of a fully equity financed project with discount rates of the cash flow of a debt-financed project. Furthermore we show that in general this relation may not be employed to expected returns of the project.
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Keywords: capital budgeting, wacc, risk neutral valuation
JEL Classification: G12, G31, G32
Suggested Citation: Suggested Citation