Reply to Comment on the Value of Tax Shields is Not Equal to the Present Value of Tax Shields

Abstract

The Comment is thought provoking and helps a lot in rethinking the value of tax shields. However, the conclusion of Fieten, Kruschwitz, Laitenberger, Loffler, Tham, Velez-Pareja and Wonder (2005) is not correct because, as will be proven below, the main result of Fernandez (2004) is correct for several situations.

Equation (16a) shows that the value of tax shields depends only upon the nature of the stochastic process of the net increase of debt.

Keywords: Value of tax shields, Required return to equity, leverage cost, unlevered beta, levered beta

JEL Classification: G12, G31, G32