--%>
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 : Public Finance which type of tax,

    which type of tax, direct or indirect is applicable in underdeveloped countries? Why? Show your critical areas and weaknesses.

    		•
  • Q : FIN3000 Corporate Finance Task

    Task Description Length: 1000-2000 words (up to 500 words above 2000 permitted) Description: • Complete this assignment in groups of 4-5 students. • Maintain a portfolio of financial issues taken from 8 news sources. • Analyse the articles with reference to theory covered in class and h

    		•
  • Q : Explain breakthroughs on

    Explain breakthroughs on low-discrepancy sequences.

    		•
  • Q : Financial problem regarding acquistion

    My Company paid an extremely higher price for the acquisition of other company; the price was recommended through the valuation of an investment bank. Now we have financial problems. So is there any way to make this bank legally responsible for such situation?

    		•
  • Q : Problem on arbitrage opportunity John

    John Chan considers purchasing a six-month stock futures contract on the shares of Li & Fung Limited. Shares of Li & Fung Limited are now presently trading at $50 per share and it is predicted that Li & Fung Limited will pay a dividend of $1 per share in o

    		•
  • Q : Explain new methodology of standard

    Explain new methodology of standard market practice.

    		•
  • Q : Problem on raising new capital AB

    AB Corporation has 3 million shares of common stock selling at $19 each. It also contains $25 million in bonds with coupon rate of 8%, selling at par. AB requires $10 million in new capital that it can raise by selling stock at $18, or bonds at 9% interest. The expect

    		•
  • Q : Explain realization of name valuation

    I suppose that a valuation consciously realized in my name tells me how much I have to offer for the company, am I right?

    		•
  • Q : Which method must use to valuate young

    Which method must we use to valuate young companies along with high growth but uncertain futures? Two illustrations were Boston Chicken and Telepizza while they began.

    		•
  • Q : Probability of dividend Universal

    Universal Corporation has the following dividend policy: if the earnings after taxes are less than $1 million, the dividend payout ratio will be 35%, but if these earnings are over $1 million, the dividend payout ratio will be 45%. The EBIT of Universal for next year

    		•