The Value of Tax Shields with a Fixed Book-Value Leverage Ratio

IESE Business School Working Paper No. 612

30 Pages Posted: 27 Oct 2005

See all articles by Pablo Fernandez

Pablo Fernandez

University of Navarra - IESE Business School

Date Written: October 14, 2005

Abstract

The value of tax shields depends only on the nature of the stochastic process of the net increases of debt. The value of tax shields in a world with no leverage cost is the tax rate times the current debt plus the present value of the net increases of debt. We develop valuation formulae for a company that maintains a fixed book-value leverage ratio and show that it is more realistic than to assume, as Miles-Ezzell (1980) do, a fixed market-value leverage ratio. We also show that Miles-Ezzell assume that the increase of debt is proportional to the increase of the free cash flows.

Keywords: Value of tax shields, present value of the net increases of debt, required return to equity, valuation, company valuation

JEL Classification: G12, G31, G32

Suggested Citation

Fernandez, Pablo, The Value of Tax Shields with a Fixed Book-Value Leverage Ratio (October 14, 2005). IESE Business School Working Paper No. 612. Available at SSRN: https://ssrn.com/abstract=827345 or http://dx.doi.org/10.2139/ssrn.827345

Pablo Fernandez (Contact Author)

University of Navarra - IESE Business School ( email )

Camino del Cerro del Aguila 3
28023 Madrid
Spain
+34 91 357 0809 (Phone)
+34 91 357 2913 (Fax)

HOME PAGE: http://web.iese.edu/PabloFernandez/

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