Tax-adjusted discount rates with investor taxes and risky debt

Ian A. Cooper () and Kjell Nyborg
Additional contact information
Ian A. Cooper: London Business School, Postal: London Business School, Regent's Park, London , NW1 4SA, United Kingdom, http://faculty.london.edu/icooper/

No 2005/15, Discussion Papers from Norwegian School of Economics, Department of Business and Management Science

Abstract: This paper derives tax-adjusted discount rate formulas 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 CAPM.

Keywords: Capital structure; value of tax shields; risky debt; cost of capital; WACC (search for similar items in EconPapers)
JEL-codes: G12 G31 G32 M21 (search for similar items in EconPapers)
Pages: 20 pages
Date: 2005-12-22, Revised 2007-09-20
New Economics Papers: this item is included in nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Tax‐Adjusted Discount Rates with Investor Taxes and Risky Debt (2008)
Working Paper: Tax-Adjusted Discount Rates with Investor Taxes and Risky Debt (2008)
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