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Marginal versus Average Beta of Equity under Corporate Taxation

Diderik Lund

No 12/2009, Memorandum from Oslo University, Department of Economics

Abstract: Even for fully equity-financed firms there may be substantial effects of taxation on the after-tax cost of capital. Among the few studies of these effects, even fewer identify all effects correctly. When marginal investment is taxed together with inframarginal, marginal beta differs from average if there are investmentrelated deductions like depreciation. To calculate asset betas, one should not only "unlever" observed equity betas, but "untax" and "unaverage" them. Risky tax claims are valued as call options, with closed-form solutions for the exercise probability. Results have practical relevance for multinationals operating under different tax systems.

Keywords: Cost of capital; WACC; loss offset; tax shields; options (search for similar items in EconPapers)
JEL-codes: F23 G31 H25 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-acc and nep-cfn
Date: 2009-06-09
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Published as Lund, Diderik, 'How taxes on firms reduce the risk of after-tax cash flows' in FinanzArchiv/Public Finance Analysis, 2014, pages 567-598.

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