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Tax shields, financial expenses and losses carried forward

Author

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  • Ignacio Vélez-Pareja

Abstract

This article deals with the proper procedure for calculating Tax Shields (TS). The calculation includes cases where Losses Carried Forward are allowed and there is financial Other Income (OI). The procedure takes into account the magnitude of Adjusted Earnings before Interest and Taxes (EBITAdj) —that is, EBIT + OI – OE excluding Financial— compared with Financial Expenses (FE). This comparison defines three intervals and results for TS. If EBITAdj. 0 and less than FE, TS is T × EBITAdj.; finally if EBITAdj. > FE, TS is T × FE. When firm possesses OI, TS are not equivalent to the difference in taxes and an adjustment is needed. Proper calculation of TS is important because their value might represent a substantial part of firm value. ***** Este artículo define el procedimiento adecuado para calcular los ahorros en impuestos (AI). Incluye el caso en que se permiten pérdidas amortizadas y hay otros ingresos financieros. El procedimiento compara la utilidad antes de intereses e impuestos ajustada (UAIIAj) —eso es UAII+OI–OE excl. Financieros— en comparación con los gastos financieros (GF). Esto define tres intervalos y resultados para AI. Si UAIIAj 0 y menor que GF, AI es T x UAIIAj, por último, si UAIIAj > GF, AI es T x GF. Cuando existen otros ingresos financieros, los AI no son la diferencia en los impuestos y se necesita un ajuste. Calcular adecuadamente los AI es relevante debido a que su valor podría ser una parte importante del valor de la empresa.

Suggested Citation

  • Ignacio Vélez-Pareja, 2016. "Tax shields, financial expenses and losses carried forward," Revista Cuadernos de Economia, Universidad Nacional de Colombia, FCE, CID, vol. 35(69), pages 663-689, April.
    • Handle: RePEc:col:000093:014606
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    References listed on IDEAS

    as
    1. Cooper, Ian A. & Nyborg, Kjell G., 2006. "The value of tax shields IS equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 81(1), pages 215-225, July.
    2. Brennan, Michael J & Schwartz, Edwardo S, 1978. "Corporate Income Taxes, Valuation, and the Problem of Optimal Capital Structure," The Journal of Business, University of Chicago Press, vol. 51(1), pages 103-114, January.
    3. repec:bla:econom:v:59:y:1992:i:233:p:93-106 is not listed on IDEAS
    4. Massimiliano Barbi, 2012. "On the risk-neutral value of debt tax shields," Applied Financial Economics, Taylor & Francis Journals, vol. 22(3), pages 251-258, February.
    5. Cooper, Ian & Franks, Julian R, 1983. "The Interaction of Financing and Investment Decisions When the Firm Has Unused Tax Credits," Journal of Finance, American Finance Association, vol. 38(2), pages 571-583, May.
    6. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(3), pages 719-730, September.
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    Cited by:

    1. Lucia MICHALKOVA & Tomas KLIESTIK, 2019. "The Role Of Risk In The Valuation Of Tax Shield," Proceedings of the INTERNATIONAL MANAGEMENT CONFERENCE, Faculty of Management, Academy of Economic Studies, Bucharest, Romania, vol. 13(1), pages 218-233, November.

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    More about this item

    Keywords

    Weighted Average Cost of Capital (WACC); firm valuation; tax shields; tax savings; losses carried forward;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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