Harris and pringle 1985 propose that the present

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Unformatted text preview: V [Ku; D Kd T] Harris and Pringle (1985, page 242) say “the MM position is considered too extreme by some because it implies that interest tax shields are no more risky than the interest payments themselves. The Miller position is too extreme for some because it implies that debt cannot benefit the firm at all. Thus, if the truth about the value of tax shields lies somewhere between the MM and Miller positions, a supporter of either Harris and Pringle or Miles and Ezzell can take comfort in the fact that both produce a result for unlevered returns between those of MM and Miller. A virtue of Harris and Pringle compared to Miles and Ezzell is its simplicity and straightforward intuitive explanation.” Ruback (1995, 2002) reaches equations that are identical to those of Harris-Pringle (1985). Kaplan and Ruback (1995) also calculate the VTS “discounting interest tax shields at the discount rate for an all-equity firm”. Tham and VélezPareja (2001), following an arbitrage argument, also claim that the appropriate discount rate for the tax shield is Ku, the required return on unlevered equity. Fernández (2002) shows that Harris and Pringle (1985) provide inconsistent results. Damodaran (1994, page 31) argues that if all the business risk is borne by the equity, then the equation relating the levered beta (ßL) to the asset beta (ßu) is: [30] ßL = ßu + (D/E) ßu (1 - T) It is important to note that equation [30] is exactly the same as equation [22] assuming that ßd = 0. One interpretation of this assumption is that all of the firm’s risk is borne by the stockholders (i.e., the beta of the debt is zero). However, we think that it is difficult to justify that the debt has no risk (unless the cost of debt is the risk-free rate) and that the return on the IESE Business School-University of Navarra - 17 Appendix 1 (continued) debt is uncorrelated with the return on assets of the firm. We rather interpret equation [30] as an attempt to introduce some leverage costs into the valuation; for a gi...
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