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not equal to its book value (Appendix 3). IESE Business School-University of Navarra - 15 Appendix 1
A Brief Overview of the Most Significant Papers on the Discounted Cash Flow Valuation of Firms There is a considerable body of literature on the discounted cash flow valuation of firms. We
will now discuss the most salient papers, concentrating particularly on those that propose
different expressions for the present value of the tax savings due to the payment of interest or
value of tax shields (VTS). The main problem with most papers is that they consider the value
of tax shields (VTS) as the present value of the tax savings due to the payment of interest.
Fernández (2004) argues that the value of tax shields (VTS) is the difference between two
present values: the present value of taxes paid by the unlevered firm and the present value of
taxes paid by the levered firm.
Modigliani and Miller (1958) studied the effect of leverage on the firm’s value. Their
proposition 1 (1958, equation 3) states that, in the absence of taxes, the firm’s value is
independent of its debt, i.e.,
 E + D = Vu, if T = 0
E is the equity value, D is the debt value, Vu is the value of the unlevered company, and T is
the tax rate.
In the presence of taxes and for the case of a perpetuity, they calculate the value of tax shields
(VTS) by discounting the present value of the tax savings due to interest payments on a riskfree debt (T D RF) at the risk-free rate (RF). Their first proposition, with taxes, is transformed
into Modigliani and Miller (1963, page 436) equation 3:
 E + D = Vu + PV[RF; DT RF] = Vu + D T
DT is the value of tax shields (VTS) for perpetuity. This result is only correct for perpetuities. As
Fernández (2004) demonstrates, discounting the tax savings due to interest payments on a
risk-free debt at the risk-free rate provides inconsistent results for growing companies. We have
seen this in Table 13.
Myers (1974) introduced the APV (adjusted present value). According to Myers, the value of
the levered firm is equal to the value of the firm with no debt (Vu) plus the present value of the
tax saving due to th...
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This note was uploaded on 05/10/2013 for the course MBA MBA taught by Professor Mba during the Fall '11 term at ESLSCA.
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