The Value of Tax Shields is Equal to the Present Value of Tax Shields

London Business School Institute of Finance No. IFA-428

9 Pages Posted: 15 Oct 2004

See all articles by Ian A. Cooper

Ian A. Cooper

London Business School

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Multiple version iconThere are 3 versions of this paper

Date Written: October 2004

Abstract

In a recent paper, Fernandez (2004) argues that the present value effect of the tax saving on debt cannot be calculated as simply the present value of the tax shields associated with interest. This contradicts standard results in the literature. It implies that, even though the capital market is complete, value-additivity is violated. As a consequence, adjusted present value formulae of a standard sort cannot be used. Also, it implies that the value of the tax saving differs from conventional estimates by a considerable amount. We reconcile Fernandez' results with standard valuation formulae for the tax saving from debt. We show that, as one would expect, the value of the debt tax saving IS the present value of the tax savings from interest. The apparent violation of value-additivity in the Fernandez paper comes from mixing the Miles-Ezzell leverage policy with the Miller-Modigliani leverage adjustment.

Keywords: Tax shields, leverage, adjusted present value.

JEL Classification: G31, G32

Suggested Citation

Cooper, Ian Anthony and Nyborg, Kjell G., The Value of Tax Shields is Equal to the Present Value of Tax Shields (October 2004). London Business School Institute of Finance No. IFA-428, Available at SSRN: https://ssrn.com/abstract=603821 or http://dx.doi.org/10.2139/ssrn.603821

Ian Anthony Cooper (Contact Author)

London Business School ( email )

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

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 (0)44 634 2980 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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