The Firm's Cost of Capital, Its Effective Marginal Tax Rate, and the Value of the Government's Tax Claim

Rao Ramesh K. S. () and Stevens Eric C ()
Additional contact information
Rao Ramesh K. S.: University of Texas at Austin

The B.E. Journal of Economic Analysis & Policy, 2006, vol. 6, issue 1, 57

Abstract: This paper develops a theory of the firm's weighted average cost of capital (WACC) and the marginal tax rate with risky debt and potentially redundant depreciation and interest tax shields. The tax shields' risks, the firm's borrowing interest rate and its marginal tax rate are intertwined, and they must therefore be determined simultaneously. We capture these interdependencies by determining the borrowing interest rate endogenously, using the single-factor approximate arbitrage pricing theory. This research strategy: a) yields the correct discount rate for valuing the tax shields and shows how better WACC and marginal tax rate estimates can be generated, b) identifies the determinants of the firm's debt capacity in terms of asset characteristics and exogenous economic variables and c) specifies, numerically, how policy variables (corporate tax rate, tax rules, the risk-free rate) affect the market values of claims on the firm's output that are both private (debt, equity) and public (the tax claim).

Keywords: cost of capital; marginal tax rate; debt capacity (search for similar items in EconPapers)
Date: 2006
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://doi.org/10.2202/1538-0653.1465 (text/html)
For access to full text, subscription to the journal or payment for the individual article is required.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bpj:bejeap:v:topics.6:y:2006:i:1:n:3

Ordering information: This journal article can be ordered from
https://www.degruyter.com/journal/key/bejeap/html

DOI: 10.2202/1538-0653.1465

Access Statistics for this article

The B.E. Journal of Economic Analysis & Policy is currently edited by Hendrik Jürges and Sandra Ludwig

More articles in The B.E. Journal of Economic Analysis & Policy from De Gruyter
Bibliographic data for series maintained by Peter Golla ().