--%>
Assignment Help - homework help

How present value of tax shields be calculated

I have two valuations of the company that we set as an objective. Within one of them, the present value of tax shields (D Kd T) computed using Ku (required return to unlevered equity) and, in one, by using Kd (required return to debt). The second valuation is too higher than the first one, but here which of the two is better?

E

Expert

Verified

Fernández (2001) demonstrates that discounting the tax shields along with the Ku and the WACC is not right. There are six habitual expressions to compute the value of tax shields that are frequently used. Just three of them are valid (they have a theoretical origin):

Myers (1974) and Modigliani-Miller (1963), while the company plans to return the existing debt without making a newest one; Miles-Ezzell (1980) while the company plans its debt proportionally to market value of shares; and also Fernández (2004), while the company plans its debt proportionally to book value of the assets or shares.

Fernández (2004): VTS = VA [D Ku T; Ku].

Miles-Ezzell (1980): VA[Ku; D T Kd] (1+Ku)/ (1+Kd)

Myers (1974) and Modigliani-Miller (1963): VTS = VA[Kd; D T Kd]. Other incorrect formulae to calculate the value of tax shields are:

Damodaran (1994): VA [Ku; DTKu – D (Kd – RF) (1–T)];

Practitioners: VA [Ku; DTKd – D(Kd – RF)]

Harris-Pringle (1985) y Ruback (1995, 2002): VA [Ku; D T Kd]

Myers (1974) has to be used only while it is possible to know with whole certainty the amount of the debt at any future instant. Miles y Ezzell (1980) has to be used only when the future debt is proportional to market value of the shares that we are not aware of any company which manages its debt in such a way. Fernández (2004) has to be used only when the risk of the future raise of the debt is the same to that of the FCF.

   Related Questions in Corporate Finance

  • Q : Zurich Pvt Ltd. You have joined Zurich

    You have joined Zurich Pvt. Ltd as a Finance manager. You are given the following information: Zurich Pvt Ltd. is a diversified manufacturing firm dealing with electrical appliances. In 2012, the firm reported an operating income of Rs. 857.60 million and faced a tax rate of 35% on income. The firm

    		•
  • Q : Financing EBIT problem Rusk Inc needs

    Rusk Inc needs $50 million in new capital that it might obtain by selling bonds at par with coupon of 12% or by selling stock at $40 (net) per share. The current capital structure of Rusk consists of $300 million (face value) of 10% coupon bonds selling at 90 and 10 m

    		•
  • Q : Explain the structure

    Our company (A) is going to buy the other company (B). We need to value the shares of B and, thus, we will use three options of the structure Debt/Shareholders’ Equity in order to obtain the WACC as: 1) Present structure of A

    		•
  • Q : Calculate their after tax cost of debt

    Your Corp, Inc. has a corporate tax rate of 35%. Please calculate their after tax cost of debt expressed as a percentage. Your Corp, Inc. has several outstanding bond issues all of whichrequire semiannual interest payments. Bond A has a coupon rate of 4.0%; a price qu

    		•
  • Q : Which capital structure must consider

    Which capital structure must we consider when estimating the WACC for a subsidiary valuation: the one which is reasonable according to the risk of the subsidiary’s business that the average of the company or the one the subsidiary as “tolerates/per

    		•
  • Q : Finc . A&B Enterprises is trying to

    . A&B Enterprises is trying to select the best investment from among four alternatives. Each alternative involves an initial outlay of $100,000. Their cash flows follow: Year A B C D 1 $10,000 $50,000 $25,000 $ 0 2 20,000 40,000 25,000 0 3 30,000 30,000 25,000 45,0

    		•
  • Q : Calculated betas when they give

    Calculated betas give different information if they are acquired by using weekly, monthly or daily data.

    		•
  • Q : Additive risk in the CAPM Suppose that

    Suppose that the two securities APPL and MSFT account for the entire large cap technology component of the S&P 500 (hypothetically – of course – there are really plenty of others). Further, suppose that their weights in the S&P index were as follow

    		•
  • Q : Leverage ratio problem Handy Inc has

    Handy Inc has debt-to-assets ratio of 40%, tax rate of 35%, and total value of $100 million. W. C. Handy, the CFO, would like to increase the leverage ratio to 42%, and he believes that there will be no change in the bankruptcy cost of the company. How many dollars wo

    		•
  • Q : What is Stock Market Stock Market : To

    Stock Market: To trade company shares (or stock) and derivatives, a stock market or equity market is public entity where these shares and derivatives are sold at agreed price. These are to be listed on a stock exchange in order to trade publicly.

    		•