Tax-Adjusted Discount Rates With Investor Taxes and Risky Debt

Cooper, Ian; Nyborg, Kjell G.

doi:10.2139/ssrn.605581

Cited by 18 publications

(33 citation statements)

References 23 publications

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“…The present value of the tax shield is calculated by discounting projected interest payments at the yield of the debt. Cooper and Nyborg () show that this is consistent with no arbitrage, given certain assumptions concerning the default process for the debt adopted here…”

Section: Numerical Example Of Incorrect Valuations Using Standard Re‐supporting

confidence: 61%

“…The final ingredient is an assumption concerning the risk of PVTS . With a fixed debt plan and simplifying assumptions regarding the treatment of tax losses, Cooper and Nyborg () show that the value of the debt tax shield is given by

P V T S_{t} = \sum_{i = 0}^{\infty} \frac{D_{t + i} Y T}{{false(1 + Y false)}^{i + 1}},

where Y is the promised yield on the debt.…”

Section: The Re‐leveraging Formula For the Cost Of Equity In The Flowmentioning

confidence: 99%

“…To determine PVFS , we need a risk‐adjusted probability to use in the valuation tree. As in Cooper and Nyborg (), we derive the risk‐adjusted probability from the condition for fairly priced debt. Under the risk‐neutral probability of default, q , this must have an expected return equal to the risk‐free rate.…”

Section: Generalizationmentioning

confidence: 99%

“…In short, the paper can be viewed as reconciling the flows‐to‐equity method with APV for projects with fixed debt plans. Our approach builds on the no‐arbitrage valuation approach to valuing interest tax shields in Cooper and Nyborg (). We also expand on the basic analysis by incorporating the possibilities of mispriced debt and costs of financial distress in the equity discount rate formula.…”

Section: Introductionmentioning

confidence: 99%

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Consistent valuation of project finance and LBOs using the flows‐to‐equity method

Cooper

Nyborg

2017

Euro Fin Management

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The flows‐to‐equity method is used to value transactions where debt amortizes according to a fixed schedule, requiring a formula that links the changing leverage with a time‐varying equity discount rate. We show that extant formulas yield incorrect valuations because they are inconsistent with the basic assumptions of this method. The error from using the wrong formula can be large, especially at currently low interest rates. We derive a formula that captures the effects of a fixed debt plan, potentially expensive debt, and costs of financial distress. We resolve an important issue about what to use as the cost of debt.

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Section: Numerical Example Of Incorrect Valuations Using Standard Re‐supporting

confidence: 61%

P V T S_{t} = \sum_{i = 0}^{\infty} \frac{D_{t + i} Y T}{{false(1 + Y false)}^{i + 1}},

where Y is the promised yield on the debt.…”

Section: The Re‐leveraging Formula For the Cost Of Equity In The Flowmentioning

confidence: 99%

Section: Generalizationmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

See 2 more Smart Citations

Consistent valuation of project finance and LBOs using the flows‐to‐equity method

Cooper

Nyborg

2017

Euro Fin Management

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“…The central role of taxes in our analysis naturally relates our work to the very extensive body of work, surveyed by Auerbach () and Graham (), on the effect of taxes on considerations as varied as capital structure, organizational form, payout and compensation policies, risk and earnings management, and financial innovation. Benninga and Sarig () and Cooper and Nyborg () examine the effect of taxes on the private sector costs of debt and equity. Our concern is with the effect of taxes in introducing a wedge between public and private sector costs of capital and valuations.…”

Section: Literature Reviewmentioning

confidence: 99%

Cost of capital and valuation in the public and private sectors: Tax, risk and debt capacity

Brealey

Cooper

Habib

2019

Business Fin & Account

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Cost of capital and valuation differ in the private and public sectors, because taxes are a cost to the private sector but are only a transfer to the public sector. We show how to transform the after‐tax private sector cost of capital into its pre‐tax equivalent, for comparison with the public sector cost of capital. We establish the existence of a tax induced wedge between these two costs of capital. The wedge introduces a preference on the part of the private sector for assets with rapid tax depreciation, high debt capacity and low risk. We show that, in circumstances where an asset has identical public and private sector valuation in the absence of taxes, the tax induced difference in valuation is identical to the change in government tax receipts that results from having the asset owned by the private rather than the public sector. We provide some examples of distortions that result from failure to adjust for changes in tax revenues, and show how to effect such adjustment.

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The firm‐specific nature of debt tax shields and optimal corporate investment decisions

Eisdorfer

O’Brien

2012

Managerial Finance

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PurposeWhile an operation's unlevered value is objective, the value of the debt tax shield is subjective since it depends on the capital structure policy of the firm that owns the operation. The purpose of this paper is to explore the implications of this subjective nature of debt tax shield value for corporate investment decisions.Design/methodology/approachThe study develops a simple theoretical model.FindingsThe paper shows that even a low probability of selling a project in the future to a firm with a different tax shield value can significantly affect a project's weighted average cost of capital (WACC) and total value.Practical implicationsManagers should be aware of this issue when making corporate investment decisions.Originality/valueThis is the first study to address the implication of the subjective nature of debt tax shield value.

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Tax-Adjusted Discount Rates With Investor Taxes and Risky Debt

Cited by 18 publications

References 23 publications

Consistent valuation of project finance and LBOs using the flows‐to‐equity method

Consistent valuation of project finance and LBOs using the flows‐to‐equity method

Cost of capital and valuation in the public and private sectors: Tax, risk and debt capacity

The firm‐specific nature of debt tax shields and optimal corporate investment decisions

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