The Value of Tax Shields Depends Only on the Net Increases of Debt
IESE Business School Working Paper No. 613
30 Pages Posted: 27 Oct 2005
Date Written: October 2005
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. By applying this formula to specific situations, we show that Modigliani-Miller (1963) should be used when the company has a preset amount of debt, Fernández (2004) when the company maintains a fixed book-value leverage ratio, and Miles-Ezzell (1980) when the company maintains a fixed market-value leverage ratio.
Keywords: Value of tax shields, present value of the net increases of debt, required return to equity, valuation
JEL Classification: G12, G31, G32
Suggested Citation: Suggested Citation