A Reconsideration of Tax Shield Valuation
Year: 2005
Type: article
Abstract: A quarter-century ago, Miles and Ezzell (1980) solved the valuation problem of a firm that follows a constant leverage ratio L = D/S. However, to this day, the proper discounting of free cash flows and the computation of WACC are often misunderstood by scholars and practitioners alike. For example, it is common for textbooks and fairness opinions to discount free cash flows at WACC with beta input Bs = [1+(1-t)L]Bu, although the latter is not consistent with the assumption of constant leverage. This confusion extends to the valuation of tax shields and the proper implementation of adjusted present value procedures. In this paper, we derive a general result on the value of tax shields, obtain the correct value of tax shields for perpetuities, and state the correct valuation formulas for arbitrary cash flows under a constant leverage financial policy.
Source: European Financial Management
Authors: Enrique R. Arzac, Lawrence R. Glosten
Institution: Columbia University
Language: English
Subfield: Strategy and Management
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W3125888679