Reformulating Tax Shield Valuation: A Note

Standard financial theory (in the absence of agency costs and personal taxes) implies that each dollar of debt contributes to the value of the firm in proportion to the firm's tax rate. To derive this result, incremental debt is assumed permanent. This paper shows that when the firm acts to mai...

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Bibliographic Details
Published in:The Journal of finance (New York) 1985-12, Vol.40 (5), p.1485-1492
Main Authors: MILES, JAMES A., EZZELL, JOHN R.
Format: Article
Language:English
Subjects:
Beta
Business structures
Capital costs
Coefficients
Corporate taxes
Debt
Debt financing
Equity
Financial leverage
Impacts
Income taxes
Market value
Mathematical constants
Mathematical models
Tax rates
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Summary:Standard financial theory (in the absence of agency costs and personal taxes) implies that each dollar of debt contributes to the value of the firm in proportion to the firm's tax rate. To derive this result, incremental debt is assumed permanent. This paper shows that when the firm acts to maintain a constant market value leverage ratio, the marginal value of debt financing is much lower than the corporate tax rate. Since Hamada's [2] unlevering procedure for observed equity betas was derived under the assumption of permanent debt, we derive an unlevering procedure consistent with the assumption of a constant leverage ratio.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.1985.tb02396.x