di-0451-e

Di-0451-e

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Unformatted text preview: ys of calculating the VTS: Harris and Pringle (1985) and Myers (1974). They conclude “we leave it to the reader’s judgment to decide which approach best fits his or her situation.” They also claim that “the finance literature does not provide a clear answer about which discount rate for the tax benefit of interest is theoretically correct.” It is quite interesting to note that Copeland et al. (2000, page 483) only suggest Inselbag and Kaufold (1997) as additional reading on adjusted present value. We will consider two additional theories to calculate the value of tax shields. We label these two theories Fernández (2004) (or No-costs-of-leverage), and With-costs-of-leverage. 18 - IESE Business School-University of Navarra Appendix 1 (continued) According to Fernández (2004), the VTS is the present value of DTKu (not the interest tax shield) discounted at the unlevered cost of equity (Ku). [34] PV[Ku; D T Ku] Equation [34] is the result of considering 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. It can be seen in Fernández (2004). Comparing [31] to [34], it can be seen that [31] provides a VTS that is PV[Ku; D (Kd- RF) (1-T)] lower than [34]. We interpret this difference as a leverage cost introduced into the valuation by Damodaran. Comparing [33] to [34], it can be seen that [33] provides a VTS that is PV[Ku; D T (Ku-Kd) + D(Kd - RF)] lower than [34]. We interpret this difference as a leverage cost introduced into the valuation by the Practitioners’ method. With-costs-of-leverage. This theory provides another way of quantifying the VTS: [35] VTS = PV[Ku; D Ku T – D (Kd - RF)] One way of interpreting equation [35] is that the leverage costs (with respect to [34]) are proportional to the amount of debt and to the difference between the required return on debt and the risk-free rate. This formula can be completed with another parameter ...
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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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