Discussion Papers, Department of Finance and Management Science, Norwegian School of Economics (NHH)
No 2005/14:
The value of tax shields IS equal to the present value of tax shields
Ian A. Cooper ()
and Kjell G. Nyborg ()
Abstract: Fernandez (2004b) argues that the present value effect of
the tax saving on debt cannot be calculated as simply the present value of
the tax shields associated with interest. This contradicts standard results
in the literature. It implies that, even though the capital market is
complete, value-additivity is violated. As a consequence, adjusted present
value formulae of a standard sort cannot be used. Also, Fernandez’s
argument implies that the value of the tax saving differs from conventional
estimates by a considerable amount. We reconcile Fernandez’s results with
standard valuation formulae for the tax saving from debt. We show that, as
one would expect, the value of the debt tax saving is the present value of
the tax savings from interest. The apparent violation of value-additivity
in the Fernandez paper comes from mixing the Miles and Ezzell and Miller
and Modigliani leverage policies.
Keywords: Value of tax shields; Leverage policy; Adjusted present value; Unlevered beta; Cost of capital; (follow links to similar papers)
JEL-Codes: G12; G31; G32; (follow links to similar papers)
16 pages, December 22, 2005
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