Tax-adjusted discount rates with investor taxes and risky debt
Journal
Financial Management
Subject
Finance
Publishing details
Authors / Editors
Cooper I A; Nyborg K
Biographies
Publication Year
2008
Abstract
This paper derives a tax-adjusted discount rate formula with a constant proportion leverage policy, investor taxes, and risky debt. The result depends on an assumption about the treatment of tax losses in default. We identify the assumption that justifies the textbook approach of discounting interest tax shields at the cost of debt. We contrast this with an alternative assumption that leads to the Sick (1990) result that these should be discounted at the riskless rate. These two approaches represent polar cases. Each generates its results by using a different simplifying assumption, and we explain what determines the correct treatment in practice. We also discuss implementation of the valuation procedure using the capital asset pricing model.
Publication Research Centre
Institute of Finance and Accounting
Available on ECCH
No