Estimating the Appropriate Risk Profile for the Tax Savings: A Contingent Claim Approach

Gonzalo Diaz Hoyos () and Ignacio Velez-Pareja ()

No 7417, Proyecciones Financieras y Valoración from Master Consultores

Abstract: Tax saving´s valuation is crucial for discounted cash flow valuation and WACC estimation. There is an ongoing debate about the appropriate discount rate for tax savings under CAPM approach. On this paper we evaluate tax savings from a contingent claim approach in order to establish a framework which could be compatible with discounted cash flow valuation while being consistent with tax saving´s nature. We present two approach based on contingent claims with continuous real and risk neutral probabilities, and propose a strategy based on sequential portfolios of European options for its valuation. We state that the value of tax savings is the present value of tax savings, and provide a valuation formula that can be integrated with a traditional discount cash flow model under WACC and APV.

Keywords: Contingent Pricing; Tax Savings; WACC; Asset Pricing; Rate of Return; Risk Analysis; Discount Rate for Tax Shields; Pricing Kernel; Risk Neutral Probabilities; Stochastic Discount Factor (search for similar items in EconPapers)
JEL-codes: C19 G11 G12 G13 (search for similar items in EconPapers)
Pages: 12
Date: 2010-09-12
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Persistent link: https://EconPapers.repec.org/RePEc:col:000463:007417

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