Scandinavian Working Papers in Economics

Memorandum,
Oslo University, Department of Economics

No 12/2009: Marginal versus Average Beta of Equity under Corporate Taxation

Diderik Lund ()
Additional contact information
Diderik Lund: Dept. of Economics, University of Oslo, Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway

Abstract: Even for fully equity-financed firms there may be substantial effects of taxation on the after-tax cost of capital. Among the few studies of these effects, even fewer identify all effects correctly. When marginal investment is taxed together with inframarginal, marginal beta differs from average if there are investmentrelated deductions like depreciation. To calculate asset betas, one should not only "unlever" observed equity betas, but "untax" and "unaverage" them. Risky tax claims are valued as call options, with closed-form solutions for the exercise probability. Results have practical relevance for multinationals operating under different tax systems.

Keywords: Cost of capital; WACC; loss offset; tax shields; options

JEL-codes: F23; G31; H25

56 pages, June 9, 2009

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