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This result is only correct for perpetuities as

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Unformatted text preview: e payment of interest (VTS). Myers proposes calculating the VTS by discounting the tax savings (D T Kd) at the cost of debt (Kd). The argument is that the risk of the tax saving arising from the use of debt is the same as the risk of the debt. Therefore, according to Myers (1974): [25] VTS = PV [Kd; D T Kd] Luehrman (1997) recommends valuing companies using the adjusted present value and calculates the VTS in the same way as Myers. This theory yields inconsistent results for growing companies, as shown in Fernández (2004). Fernández (2006) shows that this theory yields consistent results only if the expected debt levels are fixed. Miller (1977) assumes no advantages of debt financing: “I argue that even in a world in which interest payments are fully deductible in computing corporate income taxes, the value of the firm, in equilibrium, will still be independent of its capital structure.” According to Miller (1977), the value of the firm is independent of its capital structure, that is, [26] VTS = 0 16 - IESE Business School-University of Navarra Appendix 1 (continued) According to Miles and Ezzell (1980), a firm that wishes to keep a constant D/E ratio must be valued in a different manner from a firm that has a preset level of debt. For a firm with a fixed debt target [D/(D+E)], they claim that the correct rate for discounting the tax saving due to debt (Kd T Dt-1) is Kd for the tax saving during the first year, and Ku for the tax saving during the following years. The expression of Ke is their equation 22: [27] Ke = Ku + D (Ku - Kd) [1 + Kd (1-T)] / [(1+Kd) E] Arzac and Glosten (2005) and Cooper and Nyborg (2006) show that equation [27] implies that the value of tax shields is: [28] VTS = PV[Ku; T D Kd] (1+Ku)/(1+Kd) Lewellen and Emery (1986) also claim that the most logically consistent method is Miles and Ezzell. Harris and Pringle (1985) propose that the present value of the tax saving due to the payment of interest (VTS) should be calculated by discounting the tax saving due to the debt (Kd T D) at the rate Ku. Their argument is that the interest tax shields have the same systematic risk as the firm’s underlying cash flows and, therefore, should be discounted at the required return on assets (Ku). Therefore, according to Harris and Pringle (1985): [29] VTS = P...
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