--%>
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 : How companies accuse investors make

    Sometimes, companies accuse investors of performing credit sales which they make their quotations fall. Is it true?

    		•
  • Q : Define Effective Utilization of Funds

    Effective Utilization of Funds: It is just the decision to maximize the return on investment of funds. When finance manager is not capable to raise the return by investing fund in profitable assets or other profitable projects, company’s busines

    		•
  • Q : What is Net Operating Profit after Tax

    What is Net Operating Profit after Tax (NOPAT)?

    		•
  • Q : Case Study 2 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 : Structure of Interest rates Which

    Which determines the shape of the term structure of Interest rates?

    		•
  • Q : What is the value of stock Brushy

    Brushy Mountain Mining Company's ore reserves are being depleted, so its sales are falling. Also, its pit is getting deeper each year, so its costs are rising. As a result, the company's earnings and dividends are declining at the constant rate of 5% per year. I

    		•
  • Q : Long-Term Debt What are Long-Term Debt

    What are Long-Term Debt and what are their main parts.

    		•
  • Q : Applied approaches to theory development

    Discuss and distinguish between the following applied approaches to theory development:  true-income (income statement and balance sheet approaches), efficient markets, and predictive ability.  You may want to include in your discussion any articles or studies that either supported or u

    		•
  • Q : Problem on stock market John Wong is a

    John Wong is a fresh graduate and has a limited amount of funds for investments. He expects that the Hong Kong stock market will fall soon but he is not familiar with derivatives. In order to gain more money to buy a car, he explores engaging in Hang Seng Index (HSI)

    		•
  • Q : Zero coupon bonds problem Shana wants

    Shana wants to purchase 5-year zero coupon bonds with a face value of $1,000. Her opportunity cost is 8.5 %. Supposing annual compounding, what would be the present market price of such bonds? (Round to the closest dollar.) (a) $1,023  (b) $665  (c) $890&nbs

    		•