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Tax-adjusted discount rates with investor taxes and risky debt

Journal

Financial Management

Subject

Finance

Publishing details

Financial Management 2008 Summer Vol 37:2 p 365-379

Authors / Editors

Cooper I A;Nyborg K

Biographies

Ian Cooper

Publication Year

2008

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 tax losses in default. We identify the assumption that justifies 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 approaches represent 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.

Publication Research Centre

Institute of Finance and Accounting

Available on ECCH

No


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