Tax Shields, WACC, NPV, EVA®, CVA®, NVA and Profitability Analyses
34 Pages Posted: 14 Jun 2004 Last revised: 10 Jun 2016
Date Written: November 16, 2006
The purpose of this paper relates to the understanding of the phenomenon of tax effects in value and profitability analyses. How to incorporate taxes into discounted cash flow calculations - dealing with the past, the present and the future - from a Value Based Management perspective? Ignoring this question, neglecting tax effects (which is normal practice in some companies) is not realistic and this conservative approach is the contrary to 'being careful' which is what is supposed to happen. Tax is a fact of life. Without correctly dealing with tax effects, all values are 'out-of-control'. Whoever is not aware of the real tax burden nor fully counts it, endangers the continued existence of the company. This is because the after-effects are self-evidently wrong decisions.
What operating surpluses are needed, at least? The bare minimum. Neither gaining nor losing money. Where is the red line? This paper gives the answer to this vexed question. It revolves around monitoring the operating surpluses on almost the top line of the cash flow calculation scheme. Periodical net cash flow information is rather late in being available. Steering on real time developing operating surpluses (to be compared to the best possible pattern that is indicating the red line) is far better than steering from the back seat, lead by various series of cash flows on the bottom line.
Though OCFD (Operating Cash Flow Demand) has been massively criticized in http://ssrn.com/abstract=378501, Weissenrieder continues to sing the praises of OCFD in http://ssrn.com/abstract=501602, posted 2004 Feb 28, revealing no counter-arguments. The latter paper is even an enlargement of the problem area. OCFD in combination with taxes as presented by Weissenrieder turns out to be an added danger.
This paper presents the author's elaboration of a numerical example in full detail, in reaction to the corresponding working-out(s) published by Weissenrieder, and may the best one prevail. Furthermore, what has been argued by so many people e.g. Pablo Fernandez about tax shields (VTS) is not true. VTS from debt as well as from depreciation has been computed too. This paper also indicates that everything written down in economic literature about 'the value of tax shields' together with 'various WACCs' is not necessary. The so-called 'appropriate discount for tax shields' exists by way of definition only, with all the resulting consequences. It can be done - quite simple really - without all of this.
Keywords: Minimal Operating Surpluses i.e. The RED LINE, VBM
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