Personal Taxes, Inflation and Valuation Under Earnings Retention Reinvestment

Ragunathan V

IIMA Working Papers from Indian Institute of Management Ahmedabad, Research and Publication Department

Abstract: Modigliani and Miller demonstrated the impact of corporate taxes on valuation. Miller, Jaffe and Modigliani among others further studied the impact of personal taxes on valuation. Amoako-Adu attempted to analyse the impact of dividend taxes on valuation. Hochman and Palmon studied the impact of inflation on the aggregate debt-asset ratio by incorporating the tax considerations of investors firms explicitly. Rashid and Amoako-Adu attempted a comprehensive analysis of the effect of inflation on the total market value. All these authors have outlined the essence of the impact of taxes and inflation on valuation quite correctly. However, MM’s, Miller’s and Hochman and Palmon’s valuation models restrict themselves to the situation, where the investment is made only at time zero. When this is not the case, their model needs to be modified suitably. Amoako-Adu, and Rashid and Amoako-Adu’s models were conceptually incorrect in that they ignored the effect of retentions and reinvestments of earnings on the market value of a firm. In this paper a comprehensive model is worked out to account for the effect of reinvested earnings on the market value of a firm. All the other models can be expressed as special cases of the model suggested in this paper.

Date: 1988-07-01
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