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Tax-adjusted discount rates with investor taxes and risky debt


Cooper, Ian; Nyborg, Kjell G (2008). Tax-adjusted discount rates with investor taxes and risky debt. Financial Management, 37(2):365-379.

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 taxlosses in default. We identify the assumption that justiftes 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 approachesrepresent 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.

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 taxlosses in default. We identify the assumption that justiftes 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 approachesrepresent 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.

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14 citations in Web of Science®
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27 citations in Microsoft Academic
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Accounting
Social Sciences & Humanities > Finance
Social Sciences & Humanities > Economics and Econometrics
Language:English
Date:1 January 2008
Deposited On:20 Jul 2012 15:37
Last Modified:11 Mar 2020 23:23
Publisher:Financial Management Association
Number of Pages:16
ISSN:0046-3892
OA Status:Green
Publisher DOI:https://doi.org/10.1111/j.1755-053X.2008.00016.x
Other Identification Number:merlin-id:6931

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