Discussion Papers, Department of Finance and Management Science, Norwegian School of Economics (NHH)
No 2007/15:
Valuing the Debt Tax Shield
Ian A. Cooper ()
and Kjell G. Nyborg ()
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.
Keywords: Tax Shields; Valuation; Risk; (follow links to similar papers)
JEL-Codes: G00; (follow links to similar papers)
27 pages, March 27, 2007
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