The Impact of Default on Tax Shield Valuation

Lahmann Alexander, Arnold Sven and Gmehling Philipp
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Lahmann Alexander: Leipzig Graduate School of Management – Junior Professorship for M&A in SME, Leipzig, Germany
Arnold Sven: Ernst & Young GmbH – Transaction Advisory Service, Hamburg, Germany
Gmehling Philipp: Department of Economics & Regulation, Leipzig Graduate School of Management, Jahnallee 59, Leipzig04109, Germany

Journal of Business Valuation and Economic Loss Analysis, 2017, vol. 12, issue 1, 41-62

Abstract: In this paper we develop a model to value debt related tax savings and associated yield rates for debt in a setting where future cash flows are uncertain and follow a stochastic diffusion process. By explicitly modeling a default trigger we find that tax shield values in standard Discounted Cash Flow (DCF) valuation formulas are too high as they do not correctly incorporate the risk of default. Furthermore, we are able to endogenously derive risk-adjusted yield rates, while keeping the overall simple and tractable structure of the DCF approach.

Keywords: discounted cash flow; tax shield; default; firm valuation; yield rates (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1515/jbvela-2016-0005

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