A model for risky cash flows and tax shields

We extend the WACC and APV frameworks by incorporating risky cash flows and the potential loss of tax shields. A closed-form solution is derived for the expected effective tax shields. Our model explains the under-leverage puzzle, and provides better estimates for the required equity return through...

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Bibliographic Details
Published in:Journal of economics and finance 2012-10, Vol.36 (4), p.868-881
Main Authors: Qi, Howard, Liu, Sheen, Johnson, Dean
Format: Article
Language:English
Subjects:
Bankruptcy
Behavior
Capital budgeting
Cash flow
Corporate debt
Corporate taxes
Discount rates
Economics
Economics and Finance
Equity
Finance
Macroeconomics/Monetary Economics//Financial Economics
Present value
Profits
Risk management
Studies
Tax rates
Tax shelters
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Summary:We extend the WACC and APV frameworks by incorporating risky cash flows and the potential loss of tax shields. A closed-form solution is derived for the expected effective tax shields. Our model explains the under-leverage puzzle, and provides better estimates for the required equity return through the improved WACC and APV formulae. It offers four empirically testable predictions.
ISSN:1055-0925
1938-9744
DOI:10.1007/s12197-010-9162-7