Valuing the Debt Tax Shield

28 Pages Posted: 12 Apr 2007

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 2 versions of this paper

Date Written: March 27, 2007

Abstract

The tax shield from debt represents a significant proportion of total value for many companies, projects, and transactions. Accurate valuation of the debt tax shield is of more importance than ever as leverage is now commonly used as a source of value added, and there is growing competition in buying assets. Changes in tax rules and more international transactions also make it important to understand how to value debt tax shields under different tax regimes.

The increased practical importance of accurate valuation of the debt tax shield has been paralleled by debates among researchers about how to do it. The different approaches have large effects on estimated values. In this article, we review these approaches and show their implications for practical debt tax shield valuation. The issue we stress is that each method relies on a few basic assumptions, primarily about the risk of debt tax shields. Picking the most appropriate assumption in any particular situation and then using only those procedures that are consistent with that assumption is the key to good valuation of debt tax shields. Using inconsistent procedures can lead to large errors.

The structure of the article is as follows: We start by giving a brief overview of the theory. Then we review the tensions that exist in the "how to value tax shields" literature. Next, we discuss the practical implications of the various approaches and show by way of an example the large errors that can arise if incorrect and inconsistent valuation methods are used. Finally, we offer our views as to which methods and assumptions are most appropriate in various real world economic settings.

Suggested Citation

Cooper, Ian Anthony and Nyborg, Kjell G., Valuing the Debt Tax Shield (March 27, 2007). NHH Dept. of Finance & Management Science Discussion Paper No. 2007/15, Available at SSRN: https://ssrn.com/abstract=979910 or http://dx.doi.org/10.2139/ssrn.979910

Ian Anthony Cooper

London Business School ( email )

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Kjell G. Nyborg (Contact Author)

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

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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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