Discussion Papers, Department of Finance and Management Science, Norwegian School of Economics (NHH)
No 2005/15:
Tax-adjusted discount rates with investor taxes and risky debt
Ian A. Cooper ()
and Kjell G. Nyborg ()
Abstract: This paper derives tax-adjusted discount rate formulas
with a constant proportion leverage policy, investor taxes, and risky debt.
The result depends on an assumption about the treatment of tax losses in
default. We identify the assumption that justifies the textbook approach of
discounting interest tax shields at the cost of debt. We contrast this with
an alternative assumption that leads to the Sick (1990) result that these
should be discounted at the riskless rate. These two approaches represent
polar cases. Each generates its results by using a different simplifying
assumption, and we explain what determines the correct treatment in
practice. We also discuss implementation of the valuation procedure using
the CAPM.
Keywords: Capital structure; value of tax shields; risky debt; cost of capital; WACC; (follow links to similar papers)
JEL-Codes: G12; G31; G32; M21; (follow links to similar papers)
20 pages, December 22, 2005, Revised September 20, 2007
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